IRC §125 · 26 U.S.C. §125
IRC §125: Cafeteria Plans
IRC §125 lets employees pick pre-tax benefits — health premiums, FSAs, dependent care — through a written plan that passes nondiscrimination testing. The salary-reduction machine behind every open enrollment.
What it governs
- Written plan required: elections, benefits, and eligibility on paper before the year starts
- Health FSA use-or-lose, softened by the carryover or grace-period option
- Dependent-care assistance up to the statutory cap per household
- Nondiscrimination testing: owners and officers can’t take it all
In the GuideFull treatment in Chapter 14 of the Guide — THE TAX CUTTERY® Guide to Federal Income Taxation, Professional Edition (564 pages, 24 chapters).
Related sectionsIRC §132 — tax-free fringes outside the cafeteria · IRC §162 — the employer’s deduction for plan costs
From the practiceStart the consultation — Paul on video, one question at a time →
Questions this section answers
- FSA or HSA — which wins?
- Different doors: FSAs need no high-deductible plan but mostly expire yearly; HSAs need the HDHP and keep forever. If the HDHP fits your health, the HSA wins outright — triple tax advantage beats use-or-lose every time.
- What happens to unused FSA money?
- The employer keeps it — use-or-lose is the statutory default. Plans may add either a small indexed carryover or a 2½-month grace period, never both. Spend down deliberately every December.
- Can owners join the cafeteria plan?
- Mostly no: sole proprietors, partners, and 2%-plus S-corp shareholders are shut out of §125’s pre-tax treatment. The plan serves rank-and-file and C-corp owners; everyone else funds benefits with after-tax dollars.
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The Guide treats 149 Code sections across 24 chapters — every claim verified against primary sources.
Get the Guide — $299