Which of the Following is Ineligible to Participate in a Section 125 Plan? [Answer Explained]

Section 125 plans, also called cafeteria plans, let employees choose between cash pay and certain pre-tax benefits, such as health coverage or a flexible spending account (FSA). Because they are employee benefit plans, the key question is who counts as an employee: which of the following is ineligible to participate in a Section 125 plan?

Eligible Participants in a Section 125 Plan

Under IRS rules, a cafeteria plan can cover current common-law employees. That includes both full-time and part-time workers, as long as the employer's plan makes them eligible.

The IRS also treats two other groups as employees for these plans: full-time life insurance agents who are current statutory employees, and certain leased employees who have worked substantially full time under the employer's direction for at least a year. An IRS FAQ adds that a plan may also cover former employees, but can't exist primarily for them.

Important Considerations:

Full-time employees: Commonly eligible.
Part-time employees: Can be eligible; it depends on the employer's plan rules.

Ineligible Participants

Some people can't participate because the law doesn't treat them as employees for cafeteria plan purposes. Others can be excluded by the employer's plan design.

Independent Contractors

Independent contractors are self-employed, not employees, so they can't participate in a client's Section 125 plan. The same goes for other self-employed people, such as sole proprietors and partners in a partnership.

IRS Publication 15-B also says not to treat a 2% shareholder of an S corporation as an employee for this purpose. Those owners are treated like partners and can't participate on a pre-tax basis.

Seasonal Workers

Seasonal workers who are common-law employees are not barred by law. Whether they can join depends on the plan: an employer may set eligibility rules, such as hours or service requirements, that leave out seasonal or temporary staff.

Summary

The clearest answer to which of the following is ineligible to participate in a Section 125 plan? is:

Independent contractors (along with other self-employed people, partners and more-than-2% S corporation shareholders)

Seasonal workers may or may not be eligible, depending on the employer's plan rules. For exact details, check your plan documents or ask your HR department; IRS Publication 15-B explains the federal rules for employers.