A Section 125 plan is a powerful tax-saving tool—but it only works if it’s structured and maintained in full compliance with federal laws. These rules are designed to protect both the employer and employees, and they cover everything from how the plan is documented to how it operates day-to-day.
Below is an overview of the key compliance areas every business should understand before implementing or updating a Section 125 plan.
The foundation of Section 125 plans is found in Internal Revenue Code Section 125, which outlines how employees can use pre-tax dollars to pay for certain benefits. The IRS requires:
A written Plan Document detailing exactly how the plan works
A Summary Plan Description (SPD) for employees
Clear rules on eligibility, contributions, and qualifying benefits
Annual nondiscrimination testing to ensure the plan doesn’t unfairly favor highly compensated employees
Failing to follow these requirements can cause the plan to lose its tax-favored status—leading to tax liabilities for both employer and employees.
If your plan includes medical coverage, it must meet the ACA’s Minimum Essential Coverage (MEC) requirements. This ensures that employees have access to affordable and adequate healthcare coverage. Employers subject to the ACA’s employer mandate must also provide proper reporting to the IRS each year.
HIPAA safeguards the privacy and security of employee health information. If your Section 125 plan handles any protected health information (PHI)—for example, through health reimbursement arrangements or wellness programs—your provider must follow HIPAA’s strict privacy and security rules.
Most Section 125 plans are considered welfare benefit plans under ERISA. This means employers must:
Provide employees with clear plan information
File annual Form 5500 (if required)
Follow fiduciary responsibilities to act in employees’ best interests
Compliance isn’t a one-time task. Your plan must be reviewed and updated regularly:
Annual nondiscrimination testing to verify fairness
Document updates if benefits or eligibility change
Open enrollment communications to ensure employees understand their options
Proper record keeping for IRS and DOL audits
While the rules may seem complex, most employers partner with a specialized Section 125 provider who handles 85%+ of the compliance work—including drafting documents, running tests, and managing required filings. This allows you to focus on your business while ensuring full compliance.
Often $2,300–$3,500 per year.
Stays the same or increases with the right plan design.
From telehealth to urgent care, at low or no cost.
Affordable dependent coverage using pre-tax contributions.
Automatic payroll deductions for predictable costs.
