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Financial Incentives

There are a variety of ways you can assist families by implementing pre-tax fringe benefit programs. Here is a summary:

What is an IRS Section 125 plan?
What are the advantages to implementing a Section 125 Plan?
What benefits may be included in a Section 125 Plan?
What is a Flexible Spending Account?
How does a Flexible Spending Account work?
How does the Dependent Care Assistance Plan (DCAP) differ from a Flexible Spending Account (FSA)?
How does a DCAP work?

What is an IRS Section 125 Plan?

A Section 125 Plan is a great way for both you and your employees to save on taxes, and it can allow you to provide benefits that make the most sense to your employees. Internal Revenue Code Section 125 describes an arrangement by which an employer establishes a plan so employees may choose to reduce pay before taxes (pre-tax contributions), thereby avoiding tax on those dollars used to purchase benefits. The amount set aside is exempt from federal and state income taxes and FICA (Social Security) and Medicare taxes for the employee, and it is exempt from the Social Security and Medicare payroll tax match for the employer.

What are the advantages to implementing a Section 125 Plan?

The key advantage of Section 125 Plans is they enable employees to extend their money by purchasing essentials with pre-tax dollars, while reducing the employers payroll tax costs. Although traditionally viewed as "big company" benefits, such plans are now accessible to even the smallest Vermont employers through a combination of outsourcing payroll services and third-party plan administrators.

What benefits may be included in a Section 125 Plan?

Benefits that may be included in a Section 125 Plan include medical, dental, vision, group-term life, disability, and dependent care assistance. In Code Section 125, the IRS refers to these types of plans as "cafeteria plans." The term "cafeteria plan" is used by the IRS to describe any arrangement in which a participant has a choice between cash (taxable) and benefits (pre-tax). However, most folks find the term Cafeteria Plan confusing, unless the Section 125 Plan actually offers an array of benefits and employer credits in a menu-like arrangement.

What is a Flexible Spending Account?

A feature of many Section 125 Plans is a special type of account—referred to by the IRS as a Flexible Spending Account (FSA)—that can be funded by the employee on a pre-tax basis. The three types currently available are medical expense, dependent care expense (e.g., child care or elder care), and adoption assistance. You may see other terms thrown about. Many businesses prefer to refer to specific Flexible Spending Accounts as a Medical Reimbursement Account, Dependent Care Reimbursement Account, or Adoption Assistance Reimbursement Account. To these employers, "reimbursement" is more descriptive of the account's function than "spending." An employer may establish one or more types of FSA accounts within a Section 125 Plan.

How does a Flexible Spending Account work?

Deductibles and anticipated uncovered medical expenses for the calendar year can be set aside in a FSA.The money set aside in the FSA is exempt from federal and state income taxes and FICA (Social Security) and Medicare taxes for the employee, and it is exempt from Social Security and Medicare payroll tax match for you as the employer. Employees incur the expenses, then are reimbursed from the FSA.

Employees must estimate anticipated expenses carefully each year, as any funds unused at the end of the calendar tax year are lost.

How Does the Dependent Care Assistance Plan (DCAP) differ from the Flexible Spending Account?

A Dependent Care Assistance Plan or DCAP is one type of flexible spending account. A DCAP is offered in the same form of salary reduction plan under which employees set aside a certain amount of pre-tax dollars each month for dependent care (child care, elder care, or special needs care). Under IRS regulations, employees can set aside up to $5,000 per calendar year ($2,500 if married and filing separate tax returns) of nontaxable income in an account for dependent care expenses. Doing so makes dependent care expenses tax-free for the employee. There is the same tax advantage to your business, as well, in that FICA (Social Security) and federal employment payroll taxes do not have to be paid on amounts provided for dependent care.

A salary reduction DCAP can be offered alone or as part of a flexible benefit program under which employees have more than one benefit option. A DCAP offered under a salary reduction plan must meet the requirements of Sections 125, including supplying employees with a written description of the plan.

How a DCAP Works