Life & Health Insurance Exam (National Portion)Taxes, Retirement, and Other Insurance ConceptsEasy
A business provides a cafeteria plan to its employees. An employee chooses to pay for their health insurance premiums and dependent care expenses through the plan. What is the tax treatment of these employee contributions?
- AContributions for health insurance premiums are tax-deductible, but dependent care expenses are not.
- BContributions are tax-free but subject to Social Security and Medicare taxes.
- CAll contributions are made with pre-tax dollars, reducing the employee's taxable income.
- DAll contributions are made with after-tax dollars and are not deductible.
Show answer & explanationAnswer & explanation
Correct answer: C. All contributions are made with pre-tax dollars, reducing the employee's taxable income.
Cafeteria plans (Section 125 plans) allow employees to pay for certain qualified benefits, such as health insurance premiums and dependent care expenses, with pre-tax dollars. This reduces their gross taxable income for federal, state, and FICA (Social Security and Medicare) tax purposes.
Why the other options are wrong
- A. Incorrect; both health insurance premiums and dependent care expenses can be paid with pre-tax dollars through a cafeteria plan.
- B. Incorrect; pre-tax contributions are generally exempt from Social Security and Medicare taxes as well, not just federal income tax.
- D. Incorrect; the primary benefit of a cafeteria plan is pre-tax contributions.
Cafeteria Plan (Section 125)
A cafeteria plan, or Section 125 plan, allows employees to choose between cash and certain qualified benefits. Employee contributions for these benefits are made on a pre-tax basis, reducing their taxable income.
- Allows employees to pay for benefits with pre-tax dollars.
- Reduces federal, state, and FICA taxes.
- Common benefits include health insurance, dependent care, flexible spending accounts.
- Must offer a choice between cash and benefits.
Memory trick: In a 'CAFETERIA' plan, you 'CHOOSE' to 'SAVE' taxes by paying 'PRE-TAX'.