Simple Cafeteria Plan: Requirements, Safe Harbor, and Tax Savings

A simple cafeteria plan is a Section 125(j) benefit arrangement that lets a small employer offer pre-tax benefits and skip the annual nondiscrimination testing that applies to standard cafeteria plans. It’s open to businesses that averaged 100 or fewer employees during either of the two preceding years. In exchange for a required employer contribution and a broad eligibility rule, the plan is treated as automatically passing the tests that catch larger employers whose benefits tilt toward executives.¹

Which Employers Qualify

Your business is eligible if it employed an average of 100 or fewer people on business days during either of the two preceding years. You calculate the average by adding the daily headcount and dividing by the number of business days.

New companies qualify as long as they reasonably expect to average 100 or fewer employees during the current year. If you grow past the threshold after adopting the plan, you don’t lose it immediately. A grace period lets you keep the simple cafeteria plan in place until you exceed 200 employees, provided you met the 100-employee test when you first set it up.¹ That gives fast-growing employers several years of runway before they need to move to a standard Section 125 plan with full testing.

Which Employees You Have to Cover

Any employee who logged at least 1,000 hours of service during the preceding plan year must be allowed to participate. That threshold captures most full-time workers and many regular part-timers.²

The statute allows only three categories of exclusion: employees under age 21, employees with less than one year of service, and employees covered by a collective bargaining agreement where benefits were the subject of good-faith negotiations. Those are the sole exclusions the safe harbor tolerates.²

Owners Usually Can’t Participate

Section 125 is limited to employees, and the tax code treats several kinds of business owner as self-employed. Sole proprietors, partners in partnerships and LLPs, and members of LLCs taxed as partnerships cannot participate in any cafeteria plan, simple or otherwise. Neither can an S-corporation shareholder who owns more than 2% of the outstanding stock or voting power.³

You can still sponsor and fund the plan for your workforce. You just can’t run your own benefits through it on a pre-tax basis.

The Required Employer Contribution

The safe harbor isn’t free. To qualify, you must commit to one of two contribution formulas. Pick one; you can’t blend them.

A nonelective contribution equal to at least 2% of each eligible employee’s compensation for the plan year, paid whether or not the employee contributes anything.
A matching contribution equal to the lesser of 100% of the employee’s salary reduction or 6% of compensation, funded at a 2-to-1 rate. If an employee contributes 2% of pay, you contribute 4%. If the employee contributes 3% or more, your contribution tops out at 6%.¹

Whichever formula you choose, apply it uniformly to every eligible employee who isn’t highly compensated or a key employee. You’re free to contribute more for the non-highly-compensated group, but you cannot give highly compensated or key employees a better rate than everyone else.¹

For 2026, a highly compensated employee is one who earned more than $160,000 in the preceding year.⁴ Key employee status is defined separately and generally covers officers above a set pay threshold and certain large shareholders.

What the Safe Harbor Actually Buys You

This is the whole reason the plan exists. A standard Section 125 plan has to pass a set of annual tests proving that eligibility, contributions, and benefit use don’t favor highly compensated participants or key employees. If a plan fails, the tax exclusion evaporates for the favored group and their elected benefits get added back to taxable income. Key employees also face a separate 25% concentration limit: if the qualified benefits provided to key employees exceed 25% of the aggregate benefits under the plan, their benefits become taxable.¹

A simple cafeteria plan that satisfies the contribution and eligibility rules is treated as passing all of those tests for the year. No year-end testing, no scramble to correct a failure.¹

Benefits You Can Offer Through the Plan

A cafeteria plan can only include what the IRS calls qualified benefits, meaning benefits that already carry their own tax exclusion elsewhere in the code. For most small employers the practical menu is:

Accident and health insurance, including medical, dental, and vision coverage under an employer group plan.
Health flexible spending accounts. For 2026, the maximum salary reduction contribution is $3,400.
Dependent care assistance for childcare or elder care that lets the employee work. The statutory annual limit is $5,000 for married couples filing jointly.
Group term life insurance. Coverage up to $50,000 per employee is tax-free; the cost of coverage above that gets included in the employee’s income.⁵
Adoption assistance, though these amounts stay subject to Social Security and Medicare taxes.

Several items are off-limits. Long-term care insurance can’t be offered through any cafeteria plan. Neither can Archer medical savings accounts, scholarships, or health coverage bought on a public marketplace exchange, with a narrow exception for small employers using the SHOP exchange.¹ Deferred compensation like 401(k) contributions runs under separate code sections and doesn’t belong inside a Section 125 plan.⁶

Tax Savings on Both Sides of the Payroll

When an employee redirects part of their salary into a cafeteria plan, that money is excluded from federal income tax withholding, from FICA, and from FUTA. The exclusion applies to both the employee’s share and the employer’s share of payroll taxes.⁷

The employer FICA and FUTA savings add up. At the combined employer FICA rate of 7.65%, a company with 50 employees each diverting $3,000 annually into the plan saves roughly $11,475 per year in payroll taxes. That often offsets a meaningful portion of the required employer contribution.

Two exceptions to the payroll tax exclusion: group term life insurance coverage above the $50,000 tax-free threshold remains subject to Social Security and Medicare taxes even when funded through the plan, and adoption assistance benefits are subject to FICA and FUTA (though still excluded from income tax withholding).⁷

Plan Documents and Filings

Every cafeteria plan must be established in writing before the first day of the plan year. The document has to describe the benefits offered, spell out the eligibility rules, identify the employer contribution formula you’ve chosen, explain how elections are made and revoked, and state the maximum salary reduction amount.⁷

A summary of the key terms goes to every eligible employee before the plan year begins. The plan document itself isn’t filed with any agency, but you have to keep it on file and produce it if an employee asks or the IRS audits.

A cafeteria plan by itself does not require a Form 5500.⁷ If the plan funds an underlying welfare benefit plan such as a self-insured health plan, that welfare plan has its own reporting rules. Welfare plans with fewer than 100 participants that are unfunded, fully insured, or a combination of both are generally exempt from Form 5500 filing; plans with 100 or more participants face additional requirements, including a possible independent audit.⁸ Because a simple cafeteria plan starts with 100 or fewer employees by definition, most sponsors in this category won’t hit those thresholds unless they outgrow the plan or run a self-funded arrangement alongside it.

1
Office of the Law Revision Counsel. 26 U.S.C. 125 – Cafeteria Plans
2
Office of the Law Revision Counsel. 26 U.S.C. 125 – Cafeteria Plans
3
Internal Revenue Service. S Corporation Compensation and Medical Insurance Issues
4
Internal Revenue Service. IRS Notice 2024-80
5
Office of the Law Revision Counsel. 26 U.S.C. 79 – Group-Term Life Insurance Purchased for Employees
6
Internal Revenue Service. Publication 15-B (2026), Employer’s Tax Guide to Fringe Benefits
7
Internal Revenue Service. FAQs for Government Entities Regarding Cafeteria Plans
8
U.S. Department of Labor. Instructions for Form 5500 Annual Return/Report of Employee Benefit Plan