What describes a cafeteria plan under IRS rules and its budgeting implications?

• A. A Section 125 plan offering pre-tax benefits; requires administration, affects take-home pay and employer tax savings; budgets must account for plan costs.
• B. A plan that eliminates all taxes for employees.
• C. A plan that only applies to retirees.
• D. A plan funded entirely by employees without employer involvement.

Answer: (A)

A cafeteria plan, or Section 125 plan, is a benefits arrangement where employees can choose from a menu of benefits and pay for those benefits with pre‑tax dollars. Because deductions occur before taxes, employees’ take-home pay changes in line with their benefit elections, and employers see payroll tax savings on the reduced taxable compensation. Implementing this kind of plan requires formal administration—a plan document, clearly defined eligibility, annual or open enrollment elections, and ongoing recordkeeping—along with nondiscrimination testing to ensure the plan isn’t tilted toward highly compensated employees.

From a budgeting standpoint, the employer must account for the costs of running the plan (administrative fees, any employer contributions, and the funded benefits) and anticipate how participation will affect payroll taxes and cash flow. The pre‑tax structure means the budget should reflect both potential tax savings and the actual costs of benefits elected, so the overall compensation budget remains balanced. This description fits a Section 125 cafeteria plan and its budgeting implications.