If you own a business in Southwest Florida and provide benefits to your employees, you need to have a Section 125 plan. A Section 125 plan enables employees to deduct their benefits pretax and therefore saving the social security tax and federal tax. The main advantage of these plans, are the tax savings realized by both employees and their employer.

The term Section 125 plan refers to the code section of the Internal Revenue Code that deals with employee benefit plans. A Section 125 plan is a written document that must meet all of the legal requirements of Section 125 for employers to enjoy the tax benefits associated with these plans. These plans are also known as Flexible Benefit Plans.

The Section 125 plan gives preferential tax treatment to three out-of-pocket expenses that are currently being paid for by employers and employees =97 insurance premiums, childcare, and medical/dental/ vision care.

Using a flexible spending plan, employees pay for the benefits they select before taxes are calculated on their wages. For example, employees get to use 100 percent of those designated dollars for benefits rather than using after-tax wages. With a minimum federal income tax rate of 15 percent and FICA of 7.65 percent, the savings are $22.65 for every $100 used for benefits. The majority of states also exempt Section 125 plan contributions from state income tax as well.

Employers can save, too. The matching 7.65 percent FICA tax is eliminated from every dollar your employees use in their plans. Employers may also enjoy savings in federal unemployment taxes. The main advantage of Section 125 plans vs. just offering benefits, are the tax savings realized by both employees and their employer.

EXAMPLE:

The employer=92s tax savings in the example above would be $38.25 per employee per month. If this employer has 10 employees, the annual payroll tax savings would be $4,590.

There are three major types of benefit plans. The first is a Premium Only Plan (POP). This plan allows employees to make their contributions to group health and group term life insurance with pre-tax dollars. A Premium Only Plan creates no new benefits. The employer is simply offering a way to obtain favorable tax treatment on benefits already offered. A POP is the simplest type of Section 125 plan, and it requires low maintenance once it has been set up.

The second type of plan is a Flexible Spending Account (FSA). This plan allows employees to use pre-tax dollars to pay dependent care expenses and medical bills not covered by their insurance. Usually offered in conjunction with a POP, the FSA is a budgeting tool that can help take care of out-of-pocket expenses such as day care, dental and optical care deductibles, co-pays, and prescription drugs. Like a POP, an FSA helps pay for itself by increasing employee take-home pay while decreasing employer payroll taxes. Out-of-pocket medical expenses can include eyeglasses and contact lenses, medical insurance deductibles, prescriptions, co-payments, orthodontia, chiropractic services, dental treatments, and X-ray and laboratory services. Dependent care expenses can include care for a child under the age of 13, care for a disabled spouse or dependent, and household-related services (i.e., visiting nurse). The flexibility of an FSA plan makes it the best option for small- to medium-sized businesses. If the employee does not spend all the money in their flexible spending account, the money goes to the employer and is taxable income to the employer.

The final plan is a Full Cafeteria Plan. A full cafeteria plan is usually a combination of a POP and FSA. Under this plan, employees receive a lump sum of money to spend on their benefits and the employer provides a menu of benefit options for employees to choose. If the employee does not use all of his allotted money toward benefit costs, whatever is leftover will be included in the employee=92s taxable income for the year. Full cafeteria plans are usually implemented in very large companies. Like any other IRS qualified plans, there are rules to observe, including:

· The plan must be properly adopted by the employer, and supported by a plan document.

· Participants must receive a Summary Plan Description outlining plan provisions.

· Owners of S corporations cannot participate.

· There are limitations on amounts contributed by key employees (owners and officers).

· An IRS Form 5500 must be completed annually.

Sole proprietors and partnerships do not qualify for Section 125 plans, but there is a different plan that can help them out. They will use a Section 105 plan. A Section 105 plan works a little differently. A self-employed person will hire his spouse, who will find health insurance that the employer pays for, either through reimbursement or directly to the insurance company. The policy covers the spouse-employee=92s family and therefore, the self-employed person will be covered as a dependent.

As with most specialty services, you need to have a professional set up the initial documents for a Section 125 plan. The fees for these services are very affordable and there are numerous professionals who can quickly get you started. Some of the local companies that handle set up include Paychex, Employee Professionals, and Smart Payroll Solutions. There is also NetPayUSA.com, a Bradenton Company, that sells primarily on the Internet. The fees for set-up range from $99 on the Internet to $700 to $1,000 if you use a larger company. There are also annual administration fees. These fees can get expensive if you have an elaborate medical savings account, but fees for normal plans are usually quite reasonable.

Many small businesses are not even aware Section 125 plans exist and the savings can be tremendous. The tax savings can quickly offset the costs of setting up a plan. Section 125 plans are easy to set up so call your accountant or employee benefits coordinator to start taking advantage of this overlooked tax deduction.

Dave Owens is a CPA and owner of Island Financial Services an accounting firm located on Sanibel.