I n the past, the cost of fringe benefits provided to employees may have represented just a small sliver of a C corporation’s budget, but now they might take a bigger piece of the pie. The trick is to keep costs down without hurting morale by reducing or eliminating employee fringe benefits.

Strategy: Set up a Section 125 “cafeteria plan.” As the name implies, your company provides a menu of fringe benefits for employees to pick and choose from. Participating employees can sign up for those benefits that they truly value. Employees allocate contributions to a cafeteria plan via a salary reduction arrangement. The contributions reduce the employee’s salary and are therefore exempt from federal income tax and federal employment taxes. So your company doesn’t have to pay its share of federal employment taxes on employee salary reduction contributions to the cafeteria plan. It’s a win-win situation for your employees and your company. This perk wasn’t touched by the new One Big Beautiful Bill Act (OBBBA).

Here’s the whole story: A cafeteria plan must be a separate written plan maintained by an employer for employees under Section 125 of the tax code. It allows participants to receive certain benefits on a tax-free basis. Participants in the cafeteria plan must be permitted to choose among at least one taxable benefit, such as salary, and one qualified benefit. The written cafeteria plan must clearly outline all benefits and set the rules for eligibility and elections. The cafeteria plan can make benefits available to employees, their spouses and dependents. It may also include coverage of former employees, but it can’t exist primarily for ex-employees. Generally, employer contributions to the cafeteria plan are made pursuant to salary reduction agreements between the employer and the employee in which the employee agrees to contribute a portion of their salary on a pre-tax basis to pay for the qualified benefits. Salary reduction contributions aren’t actually or constructively received by the participant. Therefore, those contributions are not considered wages for federal income tax purposes. Additionally, those amounts are not subject to FICA and FUTA taxes. However, group-term life insurance exceeding $50,000 of coverage is subject to Social Security and Medicare taxes, but not FUTA tax or income tax withholding, even if it is provided as a qualified benefit in a cafeteria plan. Adoption assistance benefits in a cafeteria plan are subject to Social Security, Medicare and FUTA taxes, but not income tax withholding. If an employee elects to receive cash instead of any qualified benefit, the payment is treated as wages subject to all employment taxes. Comparison with FSAs How does a cafeteria plan differ from a flexible spending account (FSA) arrangement? An FSA is a form of a cafeteria plan, funded through salary reduction contributions, that reimburses employees for expenses incurred for certain qualified benefits. It may be offered for dependent care costs, adoption costs and health-care expenses, within certain limits (e.g., salary reduction contributions to a health-care FSA can’t exceed $3,300 for 2025). However, employees may have to cope with the “use-or-lose” rule. Under this rule, any amount left over in an employee’s account at the end of the year is forfeited. Note: An employer can choose to allow a two-and-a-half-month “grace period” after the end of the year for using up funds. Another alternative: The IRS also allows employers to let participating employees carry over from 2025 up to $660 in unused FSA funds to 2026.

Tip: Your company can offer the grace period or the carryover for health-care FSAs—or neither—but not both.