Section 125 - Flexible Spending Account Information

Under Section 125 of the Internal Revenue Code (often referred to as Cafeteria Plans),
employers can use pre-tax dollars to provide employee benefits when the employee is
participating in the costs.  The method used is salary reduction.  Instead of offering payroll
deduction to employees, the employer can offer a payroll reduction in the amount of the
employee's share of the benefits cost.  The employee receives a lower gross pay amount
thereby paying fewer state and federal tax dollars, possibly fewer FICA dollars and increasing
his take home pay.    All participants in a Section 125 Cafeteria plan must be employees of the
employer offering the plan.


Section 125 of the Internal Revenue Code allows for employees to set aside some of their
wages into Medical Reimbursement Accounts (MRA).  The money set aside in the MRA can be
used to pay for medical expenses not covered by the company's health plan. Examples of
things not covered by a health plan might be the deductible (the amount the employee spends
before the health plan will pay), non-perscription drugs, eyeglasses, etc.

The employee decides how much to put into the MRA on an annual basis.  He does this based
on his own personal situation.  He must plan ahead to estimate what he thinks an appropriate
amount may be.  Once he has selected the amount for the full year, that amount is divided by
the number of pay periods in a year.   The result of that is the amount that will be withheld from
the employee's paycheck each pay period.

The rules laid down by the IRS require a "Use it or Lose it" of those amounts.  In other words,
once the money has been selected by the employee to be withheld from his paycheck, that
money is only available to reimburse the employee for medical expenses he actually paid but
was not reimbursed by his medical plan. If there is any balance in the MRA at the end of the
year, the money in the MRA cannot be given back to the employee.  Employees are advised to
be cautious when selecting the amount they want in the MRA.


Dependent Care, whether it is for a child or a parent, can be a significant expense for
employees.  Under a Section 125 Plan, employees can use pre-tax dollars to pay this expense.  
Up to $5,000 a year can be contributed to a Dependent Care Account (DCA) on an annual basis.
* Like an MRA, the money is deducted from the employee's wages evenly each pay period.  This
account must be distinct and separate from the MRA.  Funds in an MRA cannot be used to pay
dependent care and vice versa. Unlike MRA's, only the amount of money deducted at any given
time can be reimbursed to the employee. There is minimal risk to the employer that the
employee might withdraw more than was contributed to the DCA.  Like an MRA, Federal and
State Income Taxes and FICA on the amount spent on dependent care are avoided and
become savings to the employee. Amounts reimbursed to the employee for dependent care are
reported on the employee's W-2 wage report for Income Taxes.

*$2,500 maximum if not filing jointly.


When employees enroll in a Section 125 plan, their contributions to the plan will be reduced
from their pay on each regular payday throughout the plan year.  The company will use these
amounts to pay premiums for their selected medical insurance coverage, reimburse expenses
eligible under the plan and reimburse for dependent care, if applicable.


Once employees have selected to enroll or not to enroll in the Section 125 plan, they cannot
change their mind until the beginning of the next plan year.  Employees may not change the
amount of their contribution either. If employees start out with family medical coverage and
changed to single medical coverage after the employee had already enrolled in the Section 125
plan, the law requires that you continue to contribute into the Section 125 plan at the family
medical coverage amount.  THIS MONEY CANNOT BE GIVEN BACK TO YOU.


The Internal Revenue Service will allow changes to the amount employees contribute to the
Section 125 plan for the following "Life Event" changes during the plan year:

ü   if the employee marries, divorce or legally separate

ü   if the employee, spouse, or a dependent has a change in residence

ü   if the employee has a baby or adopt a child

ü   if the employee gains or loses a dependent

ü   if there is a change in eligibility of the employee’s dependent, such as graduation from

ü   if the employee spouse starts or stops working

ü   if the employee has a change in employment status such as changing from hourly to salary

ü   if the employee working status changes from full to part time or the other way around

ü   if the employee goes on an unpaid leave of absence

ü   if there is a significant change in health coverage due to the employee spouse's employment

ü   if the employee leaves or are released from the company

ü   if the employee covered dependents become entitled to COBRA continuation coverage

ü   if the employee, spouse or dependents gain or lose Medicare or Medicaid entitlement

ü   if the employee is in receipt of a qualified medical child support order (QMED)

If one of the above occurs during the plan year employees may choose to:

renroll in the Section 125 plan (assuming they hadn't before)

elect out of the plan altogether and have no future monies go into the plan. Once employees
decide to do this, however, they cannot get back into the plan until the next enrollment date.

Change the amount of the contribution to match the change in their medical insurance
coverage caused by one of the above "Life Events".

IT IS IMPORTANT THAT YOU UNDERSTAND that if while employed you decide to drop your
medical insurance coverage, or want to change your medical reimbursement contributions
during the plan year for any reason other than a "Life Event" as explained above, the law
requires that your contribution to the Section 125 plan must continue for the remainder of the
plan year.  This means your pay will continue to be reduced by the amount of money that you
were paying for your medical insurance coverage and medical reimbursement account at the
time you enrolled in the Section 125 plan. The Internal Revenue Service forbids any refunding of
unused contributions.


Participation in the Section 125 Plan will not affect an employee's compensation for
determining benefits under any other plan sponsored by the company.  Eligibility and benefits
received will be based on pre-Section 125 wages.


One of the advantages of the Section 125 Plan is that it reduces the amount of Social Security
taxes withheld.  In 2001, Social Security tax is computed on wages up to $80,400 at 7.65% rate.  
Participation in a Section 125 Plan over an extended period of time could have an effect on the
amount of benefits received under Social Security.  The reduction in Social Security benefits is
usually minimal, if any.  Earnings over the maximum taxable base generally are not affected.

*1.45% to an unlimited maximum for Medicare Tax


A Section 125 Plan can have favorable tax effects in that the amounts contributed to the plan are
not subject to Federal Income Tax and in most states are not subject to State Income Tax as
well. However, each individual's situation is unique and any specific tax consequence from
participating in the Section 125 Plan should be determined by the employee with his personal
tax advisor.


Both the employer and the employee can realize significant savings by implementing a Section
125 Cafeteria Plan.  Careful planning is required to design a plan that meets the needs of the
specific makeup of the employees.

This document is not intended to cover all the details of the Section 125 Cafeteria Plans.  This
is a summary and overview only.  For a detailed explanation, please ask your Financial Advisor
to schedule an appointment to discuss Section 125 Cafeteria Plans in detail.


·          Acupuncture

·          Adoption fees

·          Alcoholism

·          Ambulance hire

·          Artificial limbs

·          Artificial teeth

·          Birth control pills

·          Braces

·          Braille - books and magazines

·          Chiropractors

·          Christian Science practitioners' fees

·          Coinsurance for health insurance

·          Cosmetic surgery (even though not recommended by physician)

·          Cost of operations and related treatments

·          Crutches

·          Deductible for health insurance

·          Dental fees (including orthodontia)

·          Dentures

·          Diagnostic fees

·          Drug and medical supplies

·          Employee contributions to Group Dental, Vision, Life & AD&D

·          Legal and Disability Income contributions

·          Eyeglasses, including examination fee

·          Fee of practical nurse

·          Fees for healing services

·          Fees of chiropractors

·          Fees of licensed osteopaths

·          Handicap people’ special schools

·          Hair transplants

·          Health insurance premiums including Medicare Part B payments, but Part A coverage
is not deductible unless person is 65 or over and is not entitled to Social Security benefits

·          Hearing devices and batteries

·          Home improvements motivated by medical considerations

·          Hospital bills

·          Hospitalization insurance

·          Insulin

·          Laboratory fees

·          Laetrile by prescription

·          Lead base paint removal--for children with leach poisoning

·          Life fee to retirement home for medical care

·          Membership fees in association furnishing medical services, hospitalization, and clinical

·          Nurses' fees (including nurses' board and Social Security tax where paid by taxpayer)

·          Obstetrical expenses

·          Operations

·          Orthopedic shoes

·          Oxygen

·          Physician fees

·          Psychiatric care

·          Psychologist fees

·          Retarded persons cost for special home

·          "Seeing-eye" dog and its upkeep

·          Special diets

·          Sterilization fees

·          Surgical fees

·          Therapy treatments

·          Transportation expenses primarily for rendition of medical service, i.e., railroad fare to
hospital or to recuperation home, cab fare to obstetrical cases

·          Tuition at special school for handicapped

·          Tuition fee (part), if college or private school furnishes breakdown of medical charges

·          Vitamins by prescription

·          Wheelchair

·          Wigs

·          X-rays

This is not an inclusive list.  If you have specific questions on items not on this list, contact your
local IRS office.
Flexible Spending Accounts