Section 125 Glossary — 31 Terms Defined
Plain-English reference for every term that comes up in Section 125 cafeteria plan, FICA, Workers' Comp, ERISA, ACA, COBRA, and HIPAA discussions. Each term is defined with the practical implications operators care about, plus links to deeper-dive pages where relevant.
Cafeteria Plan
An employer-sponsored plan under IRC § 125 that lets employees pay for certain qualified benefits with pre-tax dollars. The 'cafeteria' analogy: employees can pick from a menu of pre-tax benefits including health insurance premiums, FSAs, dependent care, HSA contributions, and (in the Preventive Care variant) a wellness program. The cafeteria plan structure has been federal law since 1978 and is the foundational framework for all of the Section 125 savings discussed on this site.
Section 125 (IRC § 125)
Internal Revenue Code Section 125 — the federal statute authorizing cafeteria plans. Codified at 26 U.S.C. § 125. Continuously in force since 1978. Defines what counts as a qualified benefit, eligibility rules, nondiscrimination testing requirements, and the formal plan-document framework. The full statute is at uscode.house.gov.
FICA
Federal Insurance Contributions Act tax — the combined Social Security (6.2%) and Medicare (1.45%) tax that funds those programs. Both employees and employers pay 7.65% each on taxable wages. Section 125 cafeteria plans reduce the wages on which FICA is calculated, generating direct savings on both sides. The Social Security portion caps at the annual wage base ($176,100 for 2026); Medicare applies on all wages, with an additional 0.9% surtax on wages above $200,000 for high earners.
Pre-Tax Salary Reduction
The mechanism by which a Section 125 cafeteria plan reduces an employee's taxable wages. The employee agrees to reduce their gross salary by a specific dollar amount, and that amount is excluded from federal income tax, Social Security tax, and Medicare tax calculations. The dollars are then directed to qualified pre-tax benefits (health insurance premiums, FSA contributions, the Preventive Care wellness program, etc.).
Wellness Benefit (Section 125 Variant)
The post-tax wellness reward that flows back to the employee in the Preventive Care variant of Section 125. Funded through a licensed indemnity insurance carrier (per IRS Rev. Rul. 69-154, Situation 3). Approximately $1,000/month per enrolled employee. Combined with the pre-tax salary reduction effect, produces the structural ~$72/paycheck employee raise.
Premium-Only Plan (POP)
The simplest variant of a Section 125 cafeteria plan — handles pre-tax health insurance premium payments only. About 30% of small businesses run a POP. Captures FICA savings on the premium portion (~$200-$400/employee/year) but misses the structural employee raise + full FICA savings + Workers' Comp reduction layer that the Preventive Care variant adds.
Preventive Care Plan (Section 125 Variant)
The Section 125 variant that includes a HIPAA-compliant participatory wellness program funded by an additional pre-tax salary reduction. Generates $681.60/W-2 employee/year in net employer FICA savings + ~$72/paycheck employee paycheck raise + 30-60% Workers' Comp reduction at next audit cycle. Verified compliant by HitesmanLaw P.A. (May 2025) and CBIZ Advisors LLC (August 2025).
Nondiscrimination Testing
Annual compliance testing required under IRC § 125(b) and § 125(g) that confirms a cafeteria plan doesn't disproportionately favor highly compensated or key employees. Three tests: eligibility, contributions and benefits, key employee concentration. The plan administrator runs the testing on the employer's behalf using employee census data. Most properly-structured plans pass cleanly.
Plan Document
The formal written document that establishes a Section 125 cafeteria plan. IRS-required. Specifies plan name, effective date, eligible employees, participation rules, contribution and benefit structure, qualifying-event procedures, and plan administrator. The plan administrator drafts and maintains the document; the employer signs off. Required to be in writing before employees can begin pre-tax salary reductions.
HSA — Health Savings Account
Individual tax-advantaged savings account for people enrolled in qualifying High-Deductible Health Plans. 2026 contribution limits: $4,300 individual / $8,550 family + $1,000 catch-up for age 55+. Pre-tax (income tax) contributions; tax-free growth; tax-free withdrawals for qualifying medical expenses. Coexists with Section 125 — HSA contributions can be routed through a Section 125 cafeteria plan to get both pre-income-tax AND pre-FICA treatment.
FSA — Flexible Spending Account
A Section 125 cafeteria plan account funded with pre-tax payroll contributions for eligible medical expenses. 2026 limit: $3,300 (indexed annually). Generally 'use it or lose it' — unused balance forfeited at year-end (some plans offer $640 carryover or 2.5-month grace period). General-purpose FSAs are mutually exclusive with HSAs; limited-purpose FSAs (dental/vision) and post-deductible FSAs can coexist with HSAs.
HRA — Health Reimbursement Arrangement
Employer-funded health reimbursement structure — different from cafeteria plan + HSA. Multiple HRA flavors: QSEHRA (small-employer non-group), ICHRA (individual coverage), Group HRA. HRAs reimburse employees pre-tax for qualifying medical expenses; the employer funds, the employee receives reimbursements.
QSEHRA
Qualified Small Employer Health Reimbursement Arrangement — IRS-authorized structure for employers under 50 FTEs who don't offer group health insurance. 2026 contribution limits: $6,150 self / $12,450 family. QSEHRA + Section 125 are mutually exclusive within the same employee population. See /compare/section-125-vs-qsehra for the detailed comparison.
ERISA
Employee Retirement Income Security Act — federal statute governing employer-sponsored welfare and retirement plans. Sets fiduciary obligations, plan documentation, reporting (Form 5500), and disclosure rules. Section 125 cafeteria plans intersect with ERISA through the welfare-plan components (group health, etc.). CBIZ's August 2025 review confirms Section 125 Preventive Care compliance with ERISA requirements.
ACA — Affordable Care Act
Patient Protection and Affordable Care Act of 2010 — federal statute establishing the employer mandate (Applicable Large Employers must offer affordable group health coverage), individual mandate, marketplace exchanges, and minimum essential coverage rules. Section 125 cafeteria plans are typically the structure through which employees pay their share of group health insurance pre-tax — making them a key component of ACA mandate compliance.
COBRA
Consolidated Omnibus Budget Reconciliation Act — federal statute requiring employers with 20+ employees to offer continuation of group health insurance coverage to qualified beneficiaries (employees who lose coverage due to qualifying events) for 18-36 months. COBRA continuation rules apply to the underlying group health insurance components running through Section 125, not to the wellness reward layer (which is tied to active employment).
HIPAA
Health Insurance Portability and Accountability Act — federal statute governing health information privacy and security (HIPAA Privacy Rule, Security Rule) plus participatory wellness program requirements (HIPAA wellness rules under 26 CFR § 54.9802-1). The Preventive Care variant of Section 125 uses a HIPAA-compliant participatory wellness program — meaning the wellness activity requirement is reasonable and uniform, and PHI is handled per HIPAA rules.
IRC §§ 105 and 106
IRC § 105 governs accident and health plan benefit payments — the tax treatment of payments employees receive from such plans. IRC § 106 governs employer contributions to accident and health plans. Both work alongside IRC § 125 to support the Preventive Care variant's tax structure. CBIZ's August 2025 review confirms compliance with IRC §§ 125, 105, and 106 collectively.
IRS Rev. Rul. 69-154
Internal Revenue Service Revenue Ruling 69-154, Situation 3 — published IRS authority describing the tax treatment of indemnity insurance benefit payments through a properly structured plan. The Preventive Care variant of Section 125 is built directly on this ruling. The post-tax wellness reward flows through a licensed indemnity insurance carrier; the structure is supported by Situation 3 of this ruling.
Indemnity Insurance
An insurance policy that pays a fixed dollar amount to the insured upon a covered event (vs traditional health insurance which reimburses actual medical claims). The Preventive Care variant of Section 125 uses a licensed indemnity insurance carrier to flow the post-tax wellness reward back to the employee. Different from major medical insurance — does not replace group health coverage.
Plan Administrator
The entity responsible for operating a Section 125 cafeteria plan: drafting plan documents, integrating with payroll, running annual nondiscrimination testing, handling employee enrollment communications, managing ongoing compliance. ACA Solutions Hub (Virginia Fish, CPA, Aliso Viejo, CA) is the plan administrator for the Preventive Care variant we work with. Different from a benefits broker — plan administration requires specific operational infrastructure brokers don't typically have.
Highly Compensated Employee (HCE)
For Section 125 nondiscrimination testing purposes, generally an officer, a 5%+ owner, or an employee earning above the IRS threshold (~$160,000 in 2026, indexed annually). The HCE designation triggers specific scrutiny in the contributions and benefits test to ensure the cafeteria plan doesn't disproportionately favor higher earners.
Key Employee
For the IRC § 125(b) 25% concentration test, generally an officer earning above the key-employee threshold (~$235,000 in 2026), a 5%+ owner, or a 1%+ owner earning above $160,000. The 25% test confirms key employees aren't receiving more than 25% of the plan's nontaxable benefits. The Preventive Care structure passes this test cleanly because participation is uniform across W-2 employees crossing the salary threshold.
Open Enrollment
The annual window during which employees make their Section 125 election decisions for the upcoming plan year. Typically 30-60 days before the plan year start. Outside open enrollment, employees generally can't change elections except for qualifying events (marriage, birth, divorce, employment status change, etc.).
Qualifying Event
An IRS-recognized life event that triggers the right to make mid-year changes to Section 125 elections. Categories include marriage/divorce, birth/adoption, death of spouse or dependent, change in employment status, dependent eligibility changes, residence changes affecting plan eligibility, and significant cost changes by benefits providers. Employees typically have 30 days from the event to make election changes.
Salary Reduction Agreement
The written agreement between employer and employee establishing the pre-tax salary reduction amount. Required by IRS rules to be in writing before pre-tax reductions can take effect. Typically structured per pay period (e.g., $300 biweekly) or as an annual amount. Plan administrator provides the agreement template; employee signs during enrollment.
Experience Modification (Mod) Factor
The multiplicative adjustment to Workers' Comp premium based on actual loss experience vs expected losses for the classification. Mod factors typically range 0.85-1.40 in most industries. Section 125 reduces the payroll base on which the rate × mod is multiplied — it doesn't change the mod factor itself.
ACA Employer Mandate
Affordable Care Act requirement that Applicable Large Employers (ALEs — 50+ Full-Time Equivalent employees) offer affordable, minimum-essential-coverage group health insurance to substantially all FT employees + dependents, or face penalty assessments. Section 125 cafeteria plans are typically the structure through which the employee share of premium is paid pre-tax — making Section 125 a key component of ALE mandate compliance.
Section 199A QBI Deduction
20% Qualified Business Income deduction for pass-through business owners (LLCs, S-corps, partnerships, sole proprietorships). Combines with Section 125's FICA savings for compounding tax-reduction effect at the operator level. Subject to W-2 wage and qualified property limits at higher income thresholds. Coordinate with your CPA.
Wage Base / Social Security Wage Base
The annual cap on wages subject to Social Security tax. 2026 wage base: $176,100. Medicare tax applies on all wages with no cap, plus an additional 0.9% surtax on wages above $200,000 for high earners. Section 125 pre-tax reductions reduce wages subject to all FICA components — for high-earning employees who've capped out on Social Security, the savings are slightly smaller because only the 1.45% Medicare portion applies above the wage base.
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Verified: CBIZ Advisors LLC (Aug 2025) · HitesmanLaw P.A. (May 2025)
$500K legal protection per enrolled employer · IRS Section 125 · Federal law since 1978