If you offer health insurance to your employees, the IRS requires that you maintain a specific document — and many small business owners don't know it exists. The Section 125 Premium Only Plan (or "POP”) document is required when your employees pay insurance premiums with pre-tax dollars.
This document doesn't come up often in conversations about benefits. In fact, brokers often don't mention it. But it's a legal requirement, and missing it can create real IRS exposure for your business if you are audited. So, here's what you need to know.
What is a Section 125 document?
Section 125 of the Internal Revenue Code allows employees to pay for certain benefits — most commonly, health insurance premiums — using pre-tax dollars. This means the money they pay for these premiums is deducted from their paycheck before income and payroll taxes are applied. This lowers their taxable income and saves both the employee and the employer money on payroll taxes.
To legally offer this arrangement, your company must have a formal written plan document in place: a Section 125 Premium Only Plan (POP) document.
Without this document, your employees' pre-tax deductions are technically non-compliant — meaning they could be challenged in an IRS audit, retroactively taxed, and/or your company could face penalties.
What does a Section 125 document include?
A Section 125 document outlines some guidelines for your benefit plans:
Which employees are eligible to participate
Which benefits are included (typically health, dental, and vision premiums)
The plan year (typically 12 months)
Election procedures (how employees enroll and make changes to their elections)
The document needs to be created and maintained on file before employees begin making pre-tax contributions. It typically also needs to be reviewed or renewed each plan year.
Who needs a Section 125 document?
Any employer who offers employees the option to pay for health insurance premiums on a pre-tax basis needs a Section 125 document. This applies to businesses of any size — there is no employee headcount threshold.
Even if you don't formally offer group health insurance — for example, if employees are buying their own health coverage but you let them pay for it using pre-tax dollars from their paycheck — that arrangement still triggers the IRS requirement. The same is true if you cover 100% of employee premiums, but employees pay any portion of dependent coverage. Even if none of your employees have dependents enrolled today, you'll still want a POP document on file. Why? Because in the future, when a dependent is added, the pre-tax deduction kicks in and the requirement applies. A licensed benefits advisor can help with any questions on this.
What happens if you don't have a Section 125 document?
Without a valid Section 125 document:
Pre-tax deductions may be disallowed by the IRS.
Employees could owe back taxes on contributions they made pre-tax.
Your business could face penalties and interest.
In an audit, you'd have limited ability to defend the arrangement without the written plan.
The risk increases if you've been offering pre-tax deductions for multiple years without a document in place, because your exposure accumulates over time. Many business owners don't realize this until it's too late.
Does your broker handle this?
If your health insurance is managed by an external broker, it's worth asking directly: do they create and maintain your Section 125 document? This is one of the most commonly missed compliance requirements in small business benefits.
Brokers vary widely in the degree of compliance support they offer, and Section 125 documentation often isn’t mentioned, particularly for small businesses where the broker may assume the employer or their accountant is handling it.
How Gusto handles Section 125 compliance
When you integrate your health benefits with Gusto, your Section 125 document setup is handled for you, at no additional cost. Your benefits connect directly to your payroll, so deductions are calculated and applied automatically — helping support compliance year-round.
Gusto also surfaces options for handling Section 125 compliance directly in the platform. During setup for some benefits deductions, you’ll see options to get Gusto’s help with Section 125 compliance, or to upload your existing Section 125 document.
How to get a Section 125 document
If you need a Section 125 document, here are your options:
Work with Gusto's benefits team. If you integrate your benefits with Gusto, we handle the Section 125 documentation as part of service — included with your payroll plan, at no extra cost.
Ask your current broker. If you're working with a licensed benefits broker, they may be able to prepare this document for you. If they can't, that's a useful data point.
Whichever route you take, ensure the document is formally adopted, signed, and dated before employees begin making pre-tax contributions.
A final word
Gusto's licensed Benefits Advisors set up and maintain Section 125 documentation as part of your integrated benefits, at no additional cost. If you're not sure whether your current setup is compliant, talk to a Gusto Benefits Advisor.
Disclaimers
Insurance products and services offered through Gusto Insurance Services, LLC (CA Lic # 0K28399).
This content is not to be taken as tax, legal, benefits, financial, or HR advice. Since rules and regulations change over time and can vary by location, consult a lawyer, tax, or HR expert for specific guidance.
