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Is Your Section 125 Plan Compliant?

By Rafael Garcia posted 7 days ago


A Section 125 Plan is a program that allows employees to purchase certain eligible benefits on a pre-tax basis. Regularly reviewing your plan to ensure it is compliant with Internal Revenue Code (IRC) regulations will help it remain a valuable part of your employees’ overall benefit package.

Here are the areas of your plan that should be reviewed regularly by you and your legal advisor.

Plan Document
Your Section 125 Plan must be in writing and operate in accordance with its written plan. The document should be reviewed periodically by the employer, and any changes should be made and finalized in writing. In particular, you should verify the following items are correct in the plan document:

  • Plan year;
  • Insurance benefits, carriers, and descriptions;
  • Eligibility of the insurance benefits offered under the plan;
  • Eligibility requirements for participation in the plan;
  • Flexible Spending Account (FSA) minimum and maximum contributions (if offered); and
  • Non-elective (employer) contributions and elective (employee) contributions.

Plan Design

A Section 125 Plan must offer a choice between at least one taxable benefit (such as salary) and one qualified benefit (such as major medical coverage). A plan that does not offer this choice is not a Section 125 Plan and may be disqualified by the Internal Revenue Service (IRS) in the event of an audit.

The plan must only offer eligible benefits as defined by IRC regulations. These include major medical plans (insured plans, HMOs, PPOs, high deductible health plans, and self-insured plans), dental plans, vision plans, cancer coverage, disability coverage (long and short-term), and certain term life insurance.

It could also include Flexible Spending Accounts (FSAs), such as a Healthcare Flexible Spending Account (HCFSA) or Dependent Care Account, as well as Health Savings Accounts (HSAs). Offering benefits other than eligible benefits is not allowed. You should also have signed election forms for each employee that either show the benefits elected under the Section 125 Plan or that the employee is waiving participation under the Section 125 Plan.

The Section 125 Plan design must also follow specific terms included in the document, such as those pertaining to the HCFSA grace period (if offered) and eligible mid-plan year election changes.

FSA Requirements
A Section 125 Plan that offers one or more FSAs must follow the rules established for those accounts. This includes the “uniform coverage” rule, which states that a participant’s full HCFSA annual election must be made available to him or her throughout the plan year, regardless of the amount of contributions made to the account. It must also include the “use-or-lose” rule, which requires unused elected amounts be forfeited at the end of the plan year.

You may also choose to offer the carryover provision or a grace period for your HCFSA. The carryover provision allows employees to carry over up to $500 of unused contributions into the next plan year. A grace period allows employees to continue incurring expenses for a period of time after the plan year ends. These expenses may be reimbursed from the remaining balance of the previous year's HCFSA contributions.

Note: the carryover provision and the grace period are exceptions to the associated “use-or-lose” rule.

An employer is also restricted on the use of any FSA forfeitures. Using FSA forfeitures other than as expressly allowed in the IRC Regulations could cause the Section 125 Plan to be out of compliance.

The regulations also require that FSA claims meet specific eligibility requirements and must be properly substantiated. And, the employer's Section 125 Plan cannot allow claims to be reimbursed that were incurred prior to the FSA’s period of coverage.


This blog is up to date as of April 2022 and has not been updated for changes in the law, administration or current events.

This information is intended to be educational. It is general in nature and should not be considered financial, legal or tax advice. Consult an attorney or a tax professional regarding your specific situation.