A cafeteria plan, also known as a section 125 plan, is a written plan that provides employees an opportunity to receive certain benefits on a pretax basis by allowing them to choose between receiving a taxable benefit (such as cash) or certain qualified benefits for which the law provides an exclusion from wages (such as health insurance).
A “premium-only-plan” (POP) is a basic type of cafeteria plan that allows for pretax health insurance premium contributions by employees. A POP plan offers as its sole benefit, an election between cash (for example, salary) and payment of the employee share of the employer-provided accident and health insurance premium (excludible from the employee’s gross income).
Cafeteria plans must meet the specific requirements and regulations of Section 125 of the Internal Revenue Code, which generally include the development of a written plan describing the benefits and establishing rules for eligibility and elections, as well as satisfy various tests for nondiscrimination with respect to certain highly compensated and key employees.
A section 125 plan is the only means by which an employer can offer employees a choice between taxable and nontaxable benefits without the choice causing the benefits to become taxable.