What Does Less Cafe 125 Mean on Your W2?
Understand 'less Cafe 125' on your W2. Discover how pre-tax benefits reduce your taxable income and affect your financial reporting.
The W-2 form, or Wage and Tax Statement, is an important document for taxpayers, detailing annual earnings and taxes withheld. It summarizes an individual’s compensation and deductions for federal, state, and local taxes. Notations like “less Cafe 125” often appear, causing confusion. This article clarifies the meaning and impact of these notations, explaining how pre-tax benefits influence reported income and tax liability.
Understanding Section 125 Cafeteria Plans
A Section 125 Cafeteria Plan is an employee benefit program established under Section 125 of the Internal Revenue Code. It allows employees to choose between taxable cash compensation or qualified non-taxable benefits. The term “cafeteria plan” means employees select from a “menu” of benefits, customizing their package to individual needs.
These plans offer a range of benefits on a pre-tax basis, meaning contributions are deducted from an employee’s gross pay before taxes are calculated. Common benefits include health insurance premiums, such as Premium Only Plans (POP), Flexible Spending Accounts (FSAs) for healthcare or dependent care, and Health Savings Accounts (HSAs) funded via payroll. Pre-tax contributions significantly reduce taxable income for federal, state, local, and FICA taxes (Social Security and Medicare). Section 125 plans are exclusively employer-sponsored, providing valuable benefits and payroll tax savings.
How Section 125 Plans Affect Your W-2
The impact of Section 125 plans is reflected on your W-2 form in how taxable wages are reported. Pre-tax deductions are subtracted from your gross earnings before wages are reported in Box 1, “Wages, tips, other compensation.” This means the Box 1 figure is lower than your gross salary, representing income after these adjustments. For example, an employee earning $60,000 who contributes $5,000 to a Section 125 health plan might have Box 1 wages reported as $55,000.
Beyond federal income tax wages, contributions to Section 125 plans also reduce the amounts reported in Box 3, “Social Security wages,” and Box 5, “Medicare wages.” This reduction is advantageous because it lowers the amount of income subject to FICA taxes, resulting in savings on both the employee’s and employer’s portions of Social Security and Medicare taxes. Without a Section 125 plan, these benefit contributions would be considered part of an employee’s taxable wages for all tax purposes. The phrase “less Cafe 125” or similar notations on your W-2 signifies that these pre-tax deductions have already been factored into the reported wage amounts.
Employers may also use Box 14, “Other information,” on the W-2 to provide additional details about Section 125 deductions. While Box 14 is informational and its content varies by employer, you might see codes like “Cafeteria Plan,” “Section 125,” “Pre-tax,” or specific benefit names like “FSA” or “Health Prem” listed with the total deducted amount. Box 14 informs employees about the pre-tax benefits received, but these amounts have already reduced taxable wages in Boxes 1, 3, and 5. It is important to distinguish pre-tax deductions, which reduce taxable income, from post-tax deductions, which do not affect Box 1 wages.
Tax Implications of Section 125 Plans
Participation in a Section 125 plan offers significant tax benefits to employees. By reducing the amount reported in Box 1 of the W-2, these plans lower federal income tax liability. Since less income is subject to federal tax, you pay less each pay period, effectively increasing your take-home pay. This pre-tax treatment is a financial advantage that helps manage essential benefit costs.
A significant benefit is the reduction in FICA taxes. Contributions to Section 125 plans decrease the wages subject to Social Security and Medicare taxes, as shown in Box 3 and Box 5 of your W-2. You pay less in these payroll taxes, contributing to overall tax savings. While immediate savings are clear, a lower Social Security wage base could marginally affect future Social Security benefits. For most individuals, the immediate tax savings outweigh this long-term consideration.
Beyond federal taxes, Section 125 plans can also lead to savings on state and local income taxes, although rules and tax treatment vary by jurisdiction. Many states conform to federal tax law, but some have different regulations. The lower taxable income resulting from Section 125 deductions may also affect eligibility for certain tax credits or deductions, as many are tied to Adjusted Gross Income (AGI). Reducing your AGI could qualify you for, or increase, certain tax benefits. These plans are a valuable employer benefit, providing employees with tax-efficient ways to pay for healthcare and dependent care.