What Is Sec125 on a W2 & How Does It Affect Your Taxes?

Section 125 of the Internal Revenue Code governs specific employee benefit plans. These plans enable employees to receive certain benefits on a pre-tax basis, meaning deductions are made from their gross pay before taxes are calculated. This arrangement can lead to reduced taxable income for the employee, offering a financial advantage. When reviewing a W-2 form, individuals may notice entries related to Section 125, indicating their participation and the pre-tax treatment of their chosen benefits.

Understanding Section 125 Plans

A Section 125 plan is an employer-sponsored benefit program, often known as a “cafeteria plan.” It allows employees to select between receiving taxable cash compensation or choosing from a menu of qualified, non-taxable benefits. These plans provide flexibility in benefits and offer tax advantages through pre-tax contributions.

Section 125 plans operate under IRS regulations, requiring a written document outlining terms, benefits, eligibility, and enrollment procedures. Employees reduce their salary to contribute; these contributions are not considered wages for federal income tax purposes. This pre-tax deduction helps reduce an employee’s overall taxable income.

Specific Benefits Included

Section 125 plans encompass qualified benefits that employees can fund with pre-tax dollars. Common examples include health insurance premiums for medical, dental, and vision coverage. These plans also offer Flexible Spending Accounts (FSAs), which allow employees to set aside money for healthcare expenses and dependent care costs.

While Health Savings Accounts (HSAs) are not Section 125 plans themselves, contributions to an HSA can often be made on a pre-tax basis through a Section 125 arrangement. Other benefits that may be included are accident and disability coverage, group-term life insurance (up to a certain limit), and adoption assistance. The specific benefits offered vary by employer.

Impact on Your W-2 and Taxable Income

Amounts deducted under a Section 125 plan directly influence the figures reported on an individual’s W-2 form and their overall taxable income. Contributions made to these plans are excluded from federal taxable wages, shown in Box 1 of the W-2. This means the employee’s reported income for federal tax purposes is lower than their gross pay, leading to a reduced federal income tax liability.

These pre-tax deductions are typically exempt from Social Security wages (Box 3) and Medicare wages (Box 5). This exemption results in lower Social Security and Medicare taxes withheld from an employee’s paycheck. While federal tax treatment is consistent, the treatment of Section 125 deductions for state and local income tax purposes can vary, though many states follow federal guidelines for these types of pre-tax benefits.