Common Section 125 Errors
| Error | Consequence | Correction |
|---|---|---|
| Mid-year election change without qualifying event | Employee contributions become taxable | Reverse the election change; correct payroll |
| Outdated plan document | Loss of pre-tax status | Update plan document; correct retroactively if possible |
| Failure to perform nondiscrimination testing | HCE contributions become taxable | Perform testing; implement corrective actions |
| Allowing ineligible benefits | Loss of pre-tax status for affected benefits | Remove ineligible benefits; correct retroactively |
| Failure to provide SPD | ERISA penalty ($110/day) | Provide SPD immediately; document distribution |
EPCRS Correction
The IRS's Employee Plans Compliance Resolution System (EPCRS) provides correction procedures for plan errors. The Self-Correction Program (SCP) allows plans to correct certain errors without IRS approval. The Voluntary Correction Program (VCP) allows plans to correct errors with IRS approval and reduced penalties. Use EPCRS to correct Section 125 errors before they are discovered in an audit.
Proactive Compliance
IQ Insight
Proactive compliance — annual plan document review, nondiscrimination testing, election change documentation, and SPD distribution — prevents most Section 125 errors. Build a Section 125 compliance calendar that tracks all annual requirements and assign responsibility for each task. A well-administered Section 125 plan is a significant tax benefit for both employers and employees.