What Is the Section 125 Deduction on My W-2 Form?
Unpack Section 125 on your W-2. Understand how pre-tax deductions for employer benefits reduce your taxable income.
Section 125, often called a “cafeteria plan,” is a part of the Internal Revenue Code that allows employees to pay for certain qualified benefits with pre-tax dollars. Money for these benefits is deducted from an employee’s gross pay before taxes are calculated. Its presence on a W-2 form indicates participation in such a plan, affecting an individual’s take-home pay and overall taxable income. Employees choose from a selection of benefits, similar to a cafeteria.
Understanding Section 125 Plans
A Section 125 plan allows employees to convert a portion of their taxable salary into non-taxable benefits. Contributions made to these plans are deducted from an employee’s gross earnings before federal income tax, Social Security (FICA), and Medicare taxes are withheld. This reduces the employee’s taxable income and overall tax liability.
These employer-sponsored plans offer a menu of benefits. The pre-tax contributions increase an individual’s net pay compared to paying for the same benefits with after-tax dollars. For example, an employee taxed at 30% who directs $100 pre-tax saves $30 in taxes. This system benefits both employees through tax savings and employers through reduced payroll tax liabilities.
Common Benefit Plans Under Section 125
Flexible Spending Accounts (FSAs) allow employees to set aside pre-tax dollars for eligible medical or dependent care expenses. Medical FSAs cover healthcare costs, while Dependent Care FSAs assist with childcare or elder care expenses. A key feature of FSAs is the “use-it-or-lose-it” rule, where most unused funds are forfeited at year-end, though some plans offer limited carryover or grace periods.
Health Savings Accounts (HSAs) are linked with high-deductible health plans (HDHPs). HSAs offer a triple tax advantage: contributions are tax-deductible, earnings grow tax-free, and withdrawals for qualified medical expenses are tax-free. Unlike FSAs, HSA funds roll over year to year and are owned by the employee, providing a long-term savings vehicle for healthcare costs.
Premium Only Plans (POPs) enable employees to pay their share of health, dental, and vision insurance premiums with pre-tax dollars. These plans facilitate the pre-tax payment of group insurance premiums, reducing the employee’s taxable income without involving additional accounts for medical or dependent care expenses. POPs are a straightforward way for both employees and employers to realize tax savings on insurance costs.
Identifying Section 125 Contributions on Your W-2
Contributions made under a Section 125 plan may appear in Box 12 of your W-2 form, which reports various types of compensation and benefits. Each entry in Box 12 consists of a letter code followed by an amount. For instance, Code W in Box 12 signifies employer contributions to a Health Savings Account (HSA), including amounts employees elected to contribute.
Another common code in Box 12 is DD, representing the aggregate cost of employer-sponsored health coverage. This amount is for informational purposes only and does not affect your taxable income. Codes like F, G, and H relate to Archer Medical Savings Accounts or other tax-advantaged health benefits.
Contributions to Flexible Spending Accounts (FSAs), including both health and dependent care FSAs, do not appear as a separate coded entry in Box 12. These pre-tax contributions have already reduced the taxable wages reported in Boxes 1 (Wages, Tips, Other Compensation), 3 (Social Security wages), and 5 (Medicare wages) of your W-2. However, dependent care benefits may be reported in Box 10, indicating the total amount of dependent care assistance provided by your employer.