What Is IRC 125 on Your W2 and What Does It Mean?

Internal Revenue Code (IRC) Section 125 governs employee benefit plans, often called cafeteria plans. These plans allow employees to pay for qualified benefits using pre-tax dollars, which can reduce their taxable income. This article explains Section 125 plans and their appearance on your W2 form.

Understanding Section 125 Cafeteria Plans

A cafeteria plan, defined by IRC Section 125, is a written plan maintained by an employer for employees. It allows employees to choose between cash compensation or qualified non-taxable benefits. The term “cafeteria plan” originates from the idea that employees select benefits as if from a buffet.

Employee contributions to these plans are made on a pre-tax basis. This means funds for benefits are deducted from gross pay before federal income tax, Social Security (FICA), and Medicare taxes are calculated. By reducing an employee’s taxable income, a Section 125 plan can result in lower tax liabilities.

A cafeteria plan must comply with IRS rules, including having a written plan document and offering only qualified benefits on a tax-favored basis. These plans generally cannot include benefits that defer compensation, though some exceptions, like a grace period for unused funds, may apply.

Common Benefits Under These Plans

Section 125 cafeteria plans offer qualified benefits that can be paid with pre-tax dollars. Group health insurance premiums, including medical, dental, and vision coverage, are a common example.

Flexible Spending Accounts (FSAs) are another frequently offered benefit. These include Health FSAs, which reimburse eligible out-of-pocket medical expenses, and Dependent Care Flexible Spending Accounts (DCFSAs), which cover expenses for the care of qualifying individuals to enable the employee to work. While Health Savings Accounts (HSAs) are not Section 125 plans themselves, contributions made to an HSA through a cafeteria plan are treated as pre-tax. Other benefits, such as group-term life insurance coverage up to $50,000 and adoption assistance programs, can also be offered.

How Section 125 Appears on Your W2

Amounts contributed to a Section 125 plan are reflected on your W2 form by reducing your reported taxable wages. This pre-tax deduction means the amount shown in Box 1 (Wages, Tips, Other Compensation) will be lower than your gross pay. These pre-tax contributions also reduce the amounts reported in Box 3 (Social Security Wages) and Box 5 (Medicare Wages), leading to lower Social Security and Medicare tax withholdings.

Specific codes in Box 12 of your W2 indicate pre-tax contributions. For example, Code W is used to report employer contributions to a Health Savings Account (HSA), including amounts an employee elected to contribute through a Section 125 plan. Dependent Care Flexible Spending Account (DCFSA) benefits are reported in Box 10 of the W2, with any amount over $5,000 typically included in Boxes 1, 3, and 5. While some Section 125 deductions might appear in Box 14 as informational items, their primary impact is already reflected in the reduced taxable wages in Boxes 1, 3, and 5.