IRS Section 125 Premium Only Plans were introduced by the Revenue Act of 1978. Section 125 Premium Only Plans allow employers to reduce payroll taxes by making one simple adjustment to the payroll process. Under a Section 125 Premium Only Plan employees elect to pay their portion of accident and health insurance premiums on a pre-tax or tax-free basis rather than on an after-tax basis. This creates tax savings for both the employee and the employer.

How Employees Benefit. Employees save 22.65% to 40% of their pre-tax Section 125 premium deductions. The tax savings are on city, state, and federal income taxes, including (FICA) Social Security and Medicare taxes on money used to pay for their portion of insurance premiums. Employees take-home pay is increased which helps reduce the cost of providing health coverage for family members.

How Employers Benefit. Employers benefit by reducing the matching (FICA) Social Security and Medicare taxes, and sometimes (FUTA) Federal and State unemployment taxes. Depending on the state, employers may also be eligible for worker’s compensation savings. 

Who Can Participate. Regular corporations, S corporations, limited liability companies (LLCs), partnerships, sole proprietors, professional corporations, and not-for-profits can all reduce payroll taxes by establishing a Section 125 Premium Only Plan. While the Code prohibits a sole proprietor, partner, members of an LLC (in most cases), or individuals owning more than 2% of an S corporation from participating in the Section 125 POP, owners may still benefit from the savings on payroll taxes by sponsoring the plan for their employees.