Section 125 Cafeteria Plan Document: Contents, Adoption, and Filing

A Section 125 cafeteria plan document must be in writing, adopted before the first day of the plan year, and must specifically describe every benefit offered, who is eligible, how employees make elections, how the plan is funded, the maximum contributions allowed, and the plan year. The Section 125 cafeteria plan document requirements come directly from the Internal Revenue Code and IRS guidance, and missing any of them can cost employees their pre-tax treatment and expose the employer to back payroll taxes and penalties.¹²

Required Contents of the Written Plan

Section 125 of the Internal Revenue Code defines a cafeteria plan as a written plan under which employees may choose among cash and qualified benefits. The IRS treats the following elements as non-negotiable in the document itself:

A specific list of every qualified benefit offered, such as health insurance, dental, vision, a health flexible spending account, and a dependent care flexible spending account.
Objective eligibility rules, including minimum hours, waiting periods for new hires, and any excluded classes of employees.
Election procedures covering open enrollment timing and the rules for mid-year changes.
The funding mechanism, meaning the salary reduction agreement between employer and employee and any employer contributions.
Maximum contribution amounts, especially for health and dependent care FSAs.
The plan year, defined as a specific twelve-month period governing coverage, expense eligibility, and enrollment windows.

Leaving any of these out gives the IRS grounds to treat the arrangement as something other than a qualified cafeteria plan. If that happens, all pre-tax salary reductions can be recharacterized as taxable wages, and the employer owes back payroll taxes plus penalties on the recharacterized amounts.

Election Lock-In and Mid-Year Change Rules

Cafeteria plan elections are binding for the full plan year once the enrollment window closes. An employee who chooses a coverage level or FSA amount in November cannot revise it in March simply by changing their mind. The document must state that clearly so employees understand what they are committing to.

The document also has to spell out which qualifying change-in-status events the plan will recognize and what documentation the plan will require. Treasury regulations list the categories that can permit a mid-year election change:³

Marital status changes: marriage, divorce, legal separation, annulment, or death of a spouse.
Changes in the number of dependents: birth, adoption, placement for adoption, or death of a dependent.
Employment status changes for the employee, spouse, or a dependent, including starting or leaving a job, a strike or lockout, or beginning or returning from unpaid leave.
Dependent eligibility changes, such as a dependent aging out of coverage or losing student status.
A residence change that affects which plan options are available.

The election change must be consistent with the event. A divorce cannot be used to increase a health FSA contribution; the change has to logically connect to the life event. Vague drafting here creates disputes during the plan year that are hard to resolve cleanly.

Contribution Limits the Document Must State

The plan document must set the maximum salary reduction for each type of FSA, either by referencing the applicable IRS limit or by naming a dollar amount that does not exceed it. The employer can set a lower cap, never a higher one.

For 2026, the health FSA contribution limit is $3,400, up from $3,300 in 2025.⁴ The dependent care FSA limit for 2026 is $7,500 per household for single filers and married couples filing jointly, or $3,750 for married individuals filing separately.⁵ Whatever number the document names is the ceiling employees will be held to, so it needs to be accurate.

Unused Health FSA Funds

Health FSAs run on a use-or-lose rule: unspent money at the end of the plan year is forfeited. The document can adopt one of two safety valves, but not both:

A carryover of up to $680 in unused health FSA funds into the following plan year for 2026.⁴
A grace period of an extra two and a half months after the plan year ends during which participants can incur eligible expenses against the prior year’s balance.⁶

Dependent care FSAs can also offer a grace period. Whichever option the plan adopts, or if it adopts neither, the document has to say so. Employees feel strongly about forfeited money, and an ambiguous document makes those conversations worse.

Non-Discrimination Provisions

A cafeteria plan cannot exist primarily to benefit the company’s highest-paid people. Three IRS tests apply to every standard Section 125 plan:

Eligibility test: participation rules cannot disproportionately favor highly compensated employees.
Contributions and benefits test: the value of benefits cannot skew toward highly compensated participants, and similarly situated employees must be offered the same election opportunities.
Key employee concentration test: no more than 25% of total plan benefits can go to key employees.¹

For 2026, a highly compensated employee is generally someone who earned more than $160,000 in the prior year.⁷ Key employees include officers above a certain compensation threshold, more-than-5% owners, and 1% owners earning over $150,000.⁸

If the plan fails one of these tests, only the highly compensated or key employees lose their pre-tax treatment; their salary reductions get added back to taxable income and reported on W-2s (or corrected on W-2C forms if the failure surfaces after filing). Non-highly-compensated employees keep their tax benefits. There is no formal IRS correction program for non-discrimination failures after the plan year closes, so running a test mid-year or right after open enrollment is worth building into the plan’s operating calendar.

Simple Cafeteria Plan Safe Harbor

Employers with 100 or fewer employees can avoid the non-discrimination testing exposure by structuring the plan as a “simple cafeteria plan” under Section 125(j).¹ A qualifying plan is treated as automatically passing the tests. Two conditions apply:

All employees with at least 1,000 hours of service in the preceding plan year must be eligible and able to elect any benefit the plan offers. The employer can exclude workers under age 21, those with less than one year of service, collectively bargained employees, and nonresident aliens with no U.S.-source income.
The employer must make a minimum contribution for each non-highly-compensated, non-key employee, either a uniform contribution of at least 2% of compensation, or a matching contribution of 200% of the employee’s salary reduction up to 6% of compensation, whichever is less.

An employer that grows past 100 employees can continue using the structure until headcount exceeds 200. The document must reflect the simple cafeteria plan election and the employer contribution formula to claim the safe harbor.

Who the Document Must Exclude

Not every person connected to a business can participate in its cafeteria plan. The IRS defines “employee” for Section 125 purposes to include current and former employees but explicitly excludes self-employed individuals.⁹ That catches more people than most owners expect:

Sole proprietors cannot participate in their own plan.
Partners in a partnership are treated as self-employed and are also excluded.
S corporation shareholders owning more than 2% of the company’s stock are not considered employees for cafeteria plan purposes and cannot participate in an FSA or make pre-tax elections.¹⁰

The eligibility section of the document has to reflect these exclusions in plain terms. The 2% S corporation rule trips up small businesses regularly, because the shareholder-employee often runs payroll and enrolls themselves without realizing the restriction.

Adopting the Document

Drafting starts with basic identifying information: the employer’s legal name as it appears on tax filings, the Federal Employer Identification Number, the plan year start and end dates, and the company’s legal structure. The legal structure matters because it determines which ownership restrictions apply and which entities fall under the plan.

Most employers work from a template supplied by an ERISA attorney or a third-party administrator rather than drafting from scratch. Completing the template means transferring the company’s specific decisions into the document: benefits offered, contribution formula, any employer match, excluded employee classes, treatment of unused FSA funds, and which qualifying life events will trigger mid-year changes. A mismatch between what the document says and how the plan actually operates is the single most common audit issue, so review the completed document against your actual benefits administration before anyone signs.

Formal adoption happens when an authorized officer signs the document, physically or electronically. That signature establishes the plan’s effective date for tax purposes. The document must be adopted before the first day of the plan year. Retroactive adoption is not permitted.

Amendments

Cafeteria plans change. Benefits get added or dropped, FSA limits adjust annually, carriers get replaced, and eligibility rules evolve. Every substantive change requires a written amendment. The IRS expects the written plan to match actual operations at all times, so running the plan one way while the document says something different creates the same risk as having no document at all.

Amendments should be adopted before the change takes effect. If the health FSA limit rises and you want employees to contribute up to the new maximum, the document must reflect the new number before the plan year begins. Backdating an amendment to cover a change that already took effect draws IRS scrutiny. Keep a chronological file of all amendments with the original document so you can show the plan’s history if questioned.

Summary Plan Description

Once the plan is adopted, the employer must provide a Summary Plan Description to each eligible participant within 90 days of the employee becoming covered.¹¹ The SPD is a plain-language version of the plan document covering benefits, eligibility, elections, and claims procedures. For a brand-new plan, there is a 120-day window from when the plan first becomes subject to ERISA to distribute the initial SPD.

The SPD is the document employees actually read when deciding what to elect and when disputing a denied claim. If it contradicts the plan document, that conflict creates exposure in both directions: employees may argue they relied on the SPD, while the employer may point to the underlying plan. Aligning the two eliminates that risk.

Form 5500 and Recordkeeping

Whether a cafeteria plan must file Form 5500 depends on its size and funding. A welfare plan with fewer than 100 participants at the start of the plan year is exempt from filing if it is unfunded, fully insured, or a combination of the two.¹² A cafeteria plan funded through employee salary reductions that meets DOL Technical Release 92-01 can be treated as unfunded. Most small and mid-sized employers running a standard premium-only plan or modest FSA never need to file.

Plans with 100 or more participants file electronically through EFAST2.¹³ The deadline is the last day of the seventh month after the plan year ends (July 31 for calendar-year plans), with an extension available on Form 5558. IRS late-filing penalties run $250 per day, up to $150,000 per return, and DOL can impose separate penalties on top.¹⁴

ERISA requires anyone who must file a report to keep the underlying records available for examination for at least six years after the filing date.¹⁵ For a cafeteria plan, that means holding the original document, every amendment, signed salary reduction agreements, enrollment forms, SPDs, any Form 5500 filings, and non-discrimination testing results for at least six years. Store electronic copies in a system that will outlast any single employee’s tenure. The person who set up the plan is rarely the person who has to defend it later.

1
Office of the Law Revision Counsel. 26 USC 125 Cafeteria Plans
2
Internal Revenue Service. FAQs for Government Entities Regarding Cafeteria Plans
3
eCFR. 26 CFR 1.125-4 – Permitted Election Changes
4
Internal Revenue Service. Revenue Procedure 2025-32
5
FSAFEDS. New 2026 Maximum Limit Updates
6
Internal Revenue Service. Health Savings Account Eligibility During a Cafeteria Plan Grace Period
7
Internal Revenue Service. Notice 2025-67 – 2026 Amounts Relating to Retirement Plans and IRAs
8
Internal Revenue Service. Treasury Regulation 1.416-1
9
Internal Revenue Service. Lesson 4 – Cafeteria Plans
10
Internal Revenue Service. S Corporation Compensation and Medical Insurance Issues
11
U.S. Department of Labor. Reporting and Disclosure Guide for Employee Benefit Plans
12
U.S. Department of Labor. Instructions for Form 5500
13
U.S. Department of Labor. Form 5500 Series
14
Internal Revenue Service. Penalty Relief Program for Form 5500-EZ Late Filers
15
U.S. Department of Labor. Recordkeeping in the Electronic Age