Tax Liability

Tax Liability

Overview of Section 125 Plans

Section 125 plans, also known as Cafeteria Plans, are part of the U.S. Internal Revenue Code (IRC) that allows employees to choose between taxable and nontaxable benefits. This unique arrangement enables employees to allocate a portion of their salary before taxes to pay for benefits such as health insurance, Health Savings Accounts (HSAs), and group-term life insurance, among others. The pre-tax contributions help employees save on Medicare, Social Security (FICA), and Federal Unemployment (FUTA) taxes. Additionally, employers benefit by reducing their payroll tax obligations, with average savings of 7.65% on the employee contributions for benefits.

Potential Risks

However, offering Section 125 plans is not without its risks. Two primary concerns are:


  1. Non-compliance with IRS Section 125: If an employer fails to adhere to the strict regulations governing these plans, an IRS audit could uncover errors, leading to the requirement to repay tax deficiencies, interest, and penalties. These repercussions could be retroactively applied up to 7 years.

  2. Legislative Changes: Amendments to the Section 125 tax code by Congress, especially if applied retroactively, could significantly impact the tax benefits and obligations associated with these plans.


Captive Insurance Solution

To mitigate these risks, insureCap PC has introduced a captive insurance program, specifically a Contractual Liability Insurance Policy (CLIP), designed to protect against the financial implications of non-compliance or legislative changes. This program, aims to:

  • Ensure compliance with IRS Section 125 regulations.*

  • Cover the financial obligations stemming from the indemnification clause in insureCap PC’s Master Service Agreement (MSA), which offers protection against adverse tax consequences from audits.

  • Provide peace of mind through financial security and proactive risk management.

Underwriting and Coverage

The coverage under insureCap PC is contingent upon meeting several compliance requirements, including:


  • IRS Section 125 Compliance: Ensuring the plan is offered to eligible employees and meets pre-tax premium deduction criteria.

  • Non-Discrimination Testing: Verifying the plan does not disproportionately benefit highly compensated employees.

  • Plan Document: Maintaining a comprehensive written plan document detailing eligibility, enrollment, and election processes.

  • Compliance Updates: Regularly updating plan documents and procedures to align with current tax and regulatory standards.

  • Inside Counsel: Requiring the use of legal counsel for indemnification purposes.


Limits of Liability and Coverage Terms

The liability limits under this policy are aligned with the indemnification terms of the MSA, calculated on a per-member basis. The maximum liability includes 7.65% of the pre-tax premium, plus any interest and penalties, over the contract period with a look-back period of up to three consecutive years. Coverage becomes effective after the first year of the contract and collects premiums on a per-employee, per-month basis.


In essence, the captive insurance solution through insureCap PC provides a structured approach to managing the financial risks associated with offering Section 125 plans. By adhering to strict compliance measures and leveraging indemnification coverage, insureCap aims to safeguard against potential financial exposures while ensuring the continued benefit of tax savings for both employers and employees.