Are Section 125 Deductions Subject to FICA?
Learn if your pre-tax workplace benefits reduce your Social Security & Medicare taxes.
Section 125 plans and Federal Insurance Contributions Act (FICA) taxes are key parts of U.S. employee compensation and payroll. Understanding their interaction is important for both employees and employers. This article clarifies the relationship between Section 125 deductions and FICA taxes.
Understanding Section 125 Plans
A Section 125 plan, often called a cafeteria plan, allows employees to choose between taxable cash compensation or qualified non-taxable benefits. This arrangement is governed by Section 125 of the Internal Revenue Code. Employee contributions for selected benefits are typically made on a pre-tax basis.
This pre-tax treatment means money contributed to the plan is deducted from an employee’s gross pay before federal income tax is calculated. In most cases, this also applies to state income tax, reducing an employee’s taxable income. Employers offer various benefits through these plans.
Understanding FICA Taxes
FICA stands for the Federal Insurance Contributions Act, which mandates payroll taxes used to fund Social Security and Medicare programs. These taxes are a compulsory contribution from both employees and employers. FICA taxes are generally withheld directly from an employee’s gross wages.
FICA consists of two components: Social Security tax and Medicare tax. The Social Security portion funds benefits for retirees, survivors, and disabled workers, while the Medicare portion supports health insurance for the elderly and certain disabled individuals. For employees, the combined FICA tax rate is 7.65%, comprising 6.2% for Social Security and 1.45% for Medicare, and employers typically match these contributions.
FICA Exemption for Section 125 Deductions
Qualified deductions made through a Section 125 plan are generally not subject to FICA taxes. This FICA exemption means pre-tax amounts employees contribute to a cafeteria plan are removed from their wages before FICA taxes are calculated. This benefits employees by lowering their taxable wages, which reduces their FICA withholding and increases their take-home pay.
Employers also realize savings from this exemption. Since they must match employee FICA contributions, a reduction in the employee’s FICA-taxable wages leads to lower FICA matching contributions for the employer. This regulatory treatment is defined under IRS regulations. The reduction in FICA taxable wages through Section 125 plans can result in annual savings for employers.
Common Section 125 Plan Benefits and FICA Status
Many common employee benefits offered through Section 125 plans allow for FICA-exempt contributions. Health insurance premiums, especially for group health plans, are an example. Employee contributions towards these premiums through a cafeteria plan are deducted pre-tax.
Flexible Spending Accounts (FSAs) for healthcare and dependent care are also qualified benefits within Section 125 plans. Contributions to these FSAs are taken from pay before FICA taxes are applied, providing tax savings.
Group term life insurance is another benefit where employee contributions through a Section 125 plan can be exempt from FICA taxes. These examples demonstrate how the FICA exemption applies to employee pre-tax contributions for various benefits.