Understanding Section 124 vs. Section 125 Cafeteria Plans

Employers looking for ways to provide tax-advantaged benefits to their employees may come across Section 124 and Section 125 cafeteria plans. While both sections deal with employee compensation and benefits, they serve very different purposes.

This guide breaks down the key differences between Section 124 and Section 125 plans, helping employers determine which option aligns with their business goals and workforce needs.

What Is a Section 124 Plan?

A Section 124 plan refers to Employee Stock Ownership Plans (ESOPs). These plans are designed to:

• Provide employees with company stock as part of their compensation.
• Offer long-term incentives, tying employee performance to company growth.
• Allow tax-deferred contributions toward employee stock ownership.

Key Features of Section 124 Plans

• Employees receive company stock as part of their benefits package.
• Stock ownership is held in a trust until the employee retires or leaves the company.
• Offers potential tax advantages, including deferred taxation on stock appreciation.

Who Uses Section 124 Plans?

• Privately held and public companies that want to offer equity-based compensation.
• Businesses looking to retain key employees with stock ownership incentives.

 

What Is a Section 125 Cafeteria Plan?

A Section 125 cafeteria plan is a tax-advantaged benefits program that allows employees to choose between taxable and non-taxable benefits. These plans help employees pay for healthcare, dependent care, and other benefits with pre-tax dollars.

Key Features of Section 125 Plans

• Employees can set aside pre-tax earnings for eligible benefits.
• Employers save on payroll taxes by reducing taxable wages.
• Section 125 plans include:
• Health insurance premium deductions
• Flexible Spending Accounts (FSAs)
• Dependent Care Assistance Programs (DCAPs)

For a deeper breakdown of how Section 125 plans reduce payroll taxes, read How Do Employers Calculate Payroll Tax Savings with a Section 125 Plan?.

Who Uses Section 125 Plans?

• Businesses of all sizes are looking to provide tax-advantaged employee benefits.
• Companies wanting to lower payroll tax costs while enhancing benefits.

 

Key Differences Between Section 124 and Section 125 Plans

Feature	Section 124 (ESOP)	Section 125 (Cafeteria Plan)
Purpose	Provides employees with stock ownership	Allows employees to pay for benefits with pre-tax dollars
Tax Benefit for Employees	Deferred taxation on stock gains	Reduces taxable income, increasing take-home pay
Tax Benefit for Employers	Deductible contributions to ESOPs	Reduces payroll tax liabilities
Employee Eligibility	Often limited to full-time employees	Available to most employees with employer-sponsored benefits
Flexibility	Employees receive stock but do not choose benefit options	Employees choose from a variety of pre-tax benefits
Regulatory Requirements	Subject to ERISA and IRS rules for stock plans	Must comply with IRS Section 125 rules and nondiscrimination testing

 

Which Plan Is Best for Your Business?

Choose a Section 124 Plan If:

• You want to offer stock ownership as a long-term incentive.
• Your business values employee retention through equity-based compensation.
• You are willing to manage ERISA and IRS compliance for ESOPs.

Choose a Section 125 Plan If:

• You want to lower payroll taxes while enhancing employee benefits.
• Your employees value pre-tax savings on health insurance and dependent care.
• You need a flexible benefits program that works for businesses of any size.

For businesses comparing benefits providers, read Comparing Section 125 Plan Providers: Which One Is Best for Your Business?.

 

FAQs

1. Can a company offer both Section 124 and Section 125 plans?

Yes. Many companies provide stock ownership opportunities (Section 124) and tax-advantaged benefits (Section 125) to create a comprehensive compensation package.

2. Which plan provides more immediate financial benefits to employees?

A Section 125 plan provides immediate tax savings, while a Section 124 plan offers long-term stock benefits.

3. Do Section 124 and Section 125 plans have the same tax treatment?

No.

• Section 124 (ESOPs) defer taxes until employees withdraw their stock.
• Section 125 plans offer immediate pre-tax savings on eligible benefits.

4. Do both plans require IRS compliance?

Yes, but Section 125 plans require annual nondiscrimination testing, while Section 124 ESOPs must comply with ERISA regulations.

5. Can small businesses offer Section 124 or Section 125 plans?

Yes.

• Section 124 plans work best for companies that want to offer equity-based incentives.
• Section 125 plans work well for any business looking to reduce payroll taxes and enhance employee benefits.

 

Get Started Today

Is a self-funded Section 125 plan the right fit for your business? Talk with an expert today to discover how much your company can save.

• Email: support@livestronglife.com
• Website: www.livestronglife.com

Find out if your company qualifies and start saving today.