What is a cafeteria plan?

A cafeteria plan, also known as a Section 125 plan, is a type of employee benefits program that allows employees to choose from a variety of pre-tax benefit options. The name comes from the idea that employees can “pick and choose” their benefits—similar to selecting items in a cafeteria.

Cafeteria plans are authorized under Section 125 of the Internal Revenue Code and are designed to reduce employees’ taxable income while offering flexibility in how they receive their benefits. For employers, cafeteria plans offer a way to deliver tax-advantaged benefits that support retention, satisfaction, and compliance. And with tools like Homebase, you can manage eligibility, documentation, and compliance alongside your HR and payroll operations.

How cafeteria plans work

Under a cafeteria plan, employees agree to have a portion of their wages withheld before taxes in exchange for certain benefits. These withheld amounts are not subject to federal income tax, Social Security, or Medicare taxes—offering tax savings for both employees and employers.

Eligible benefits can include:

• Health insurance premiums
  
  
• Dental and vision insurance
  
  
• Health savings accounts (HSAs) or flexible spending accounts (FSAs)
  
  
• Dependent care assistance
  
  
• Group term life insurance (up to IRS limits)
  
  
• Commuter and transportation benefits (in some cases)
  

Employees typically make their elections during open enrollment or after a qualifying life event (like marriage, birth, or job change), and those choices generally remain fixed for the rest of the plan year.

Core types of cafeteria plans

There are several types of cafeteria plans, each with specific rules and structures:

Premium-Only Plans (POPs)

• The most basic type of cafeteria plan
  
  
• Allows employees to pay insurance premiums with pre-tax dollars
  
  
• Commonly used by small businesses offering health insurance
  

Full Cafeteria Plans

• Offer a wider variety of benefit options (FSAs, dependent care, etc.)
  
  
• Require more administration and legal documentation
  
  
• Often used by larger employers or companies with comprehensive benefit offerings
  

Simple Cafeteria Plans (for small businesses)

• Specifically designed for employers with 100 or fewer employees
• Exempt from many of the nondiscrimination rules that apply to larger employers
  
  
• Must meet certain contribution and eligibility criteria
  

Simple cafeteria plans are particularly attractive to small employers who want to offer tax-advantaged benefits without triggering complex compliance burdens.

Advantages of cafeteria plans for small businesses

1. Tax savings

Cafeteria plans reduce taxable income for employees, which lowers the employer’s payroll tax liability. It’s a win-win that improves take-home pay while reducing business costs.

2. Customizable benefits

Employees can select the benefits that best suit their needs, whether that’s health coverage, child care assistance, or increased contributions to savings accounts.

3. Competitive hiring advantage

Offering a cafeteria plan—even a simple POP—can help you compete with larger companies for talent by improving the total compensation package.

4. Compliance flexibility for small teams

With a simple cafeteria plan, small employers are exempt from some complex IRS nondiscrimination tests, making it easier to offer benefits fairly and legally.

5. Improved employee satisfaction

Giving employees control over their benefits—and the ability to save on taxes—boosts morale and engagement.

Compliance and administration requirements

Cafeteria plans are governed by the IRS and must meet specific legal standards:

• Written plan document – You must have a formal plan in writing detailing how it works and what benefits are available.
  
  
• Election rules – Employee benefit elections generally must be made annually and cannot be changed mid-year unless there’s a qualifying life event.
  
  
• Nondiscrimination requirements – Plans must not favor highly compensated or key employees, unless exempt (as with simple cafeteria plans).
  
  
• Reporting – Employers may be required to include benefit values on employee W-2s and comply with ACA and ERISA regulations.
  

Because of these requirements, many small business owners work with benefit administrators, accountants, or HR software providers to set up and manage cafeteria plans properly.

How Homebase supports benefits compliance and HR organization

While Homebase doesn’t administer cafeteria plans directly, it gives you the structure and tools to support HR and compliance when managing tax-advantaged benefits:

• Digitally collect and store employee elections and forms
  
  
• Track employment status and hours for eligibility monitoring
  
  
• Keep team records centralized and secure for audits or legal requirements
  
  
• Automate time-off tracking and syncing with payroll
  
  
• Communicate updates to employees during open enrollment or benefit changes
  

Whether you’re just beginning to offer benefits or expanding your current package, Homebase can help ensure nothing falls through the cracks.

Explore Homebase HR & Compliance to simplify team management, organize benefits documentation, and stay on top of compliance with confidence.