“What may a municipality face if their Section 125 plan was implemented without a Plan Document?”
By Robert Trujillo – Published Apr 7, 2026
Municipalities are known to offer a Section 125 “cafeteria plan” in order to allow their employees to make pre-tax contributions to their benefit elections. The Internal Revenue Code authorized Section 125 plans on January 1, 1979. With this option having been around for 47 years, Employee Benefits Consultants should be fully aware of the requirements.
In spite of these long standing rules, there are municipalities that have or are still receiving inaccurate guidance. If your Employee Benefits Consultant advised you to not execute a plan document for your pre-tax Section 125 benefit plan because “ERISA does not apply to municipalities”, you likely facing at least two plan sponsor issues: 1. your Section 125 plan is likely in jeopardy, and 2. you are facing a potential fiduciary obligation to find a new Employee Benefits Consultant.
While it is true that ERISA excludes municipalities, Section 125 plans are not regulated by ERISA. These plans are governed by the requirements of the Internal Revenue Code, specifically Section 125. Under Section 125, a properly executed Plan Document is required in order to administer your plan with pre-tax deductions.
What may a municipality face if their Section 125 plan was implemented without a Plan Document?
Tax Implications – If your municipality’s Section 125 plan was implemented without an executed Plan Document, the plan may be treated as if it does not exist. This may result in all “pre-tax contributions” to be deemed taxable income. If this occurs, the employees and the municipality may face unexpected tax liabilities.
Plan Disqualification – A municipality that failed to execute a Section 125 Plan Document may lead to the disqualification of the entire cafeteria plan. If this occurs, the favorable tax treatment status of the plan may be lost, and all benefits provided through the plan may be subject to taxation.
Penalties – Municipalities may face maximum IRS penalties which may include back payment of taxes and fines.
Compliance Risks – A municipality that failed to execute a Section 125 Plan Document is susceptible audit compliance risks.
If your Employee Benefits Consultant lacks the expertise to understand that there are multiple rules from varying government agencies that regulate employee benefit plans, it would be prudent to seek a new consultant. It is also recommended that you seek guidance from your benefit plan legal counsel to discuss remedial options to this significant error.
