Section 125 Plans for Law Firms: FICA Savings and Nondiscrimination Rules

2026-07-09 • 9 min read

Law firms have a benefits wrinkle most employers do not, equity partners are not W-2 employees and cannot use a Section 125 plan. Here is how small and mid-size firms still capture real FICA savings for associates and staff in 2026.

Quick Answer (as of 2026): A Section 125 plan lets law firm employees pay health premiums with pre-tax dollars, cutting employer FICA taxes by 7.65%. Equity partners in a partnership or LLP are not W-2 employees, so they cannot participate. Associates, of counsel on payroll, paralegals, and staff can, and a typical firm recaptures $91 to $136 per enrolled employee monthly in FICA savings.

Most Section 125 guides assume every employee, including the owner, can enroll. Law firms break that assumption. A firm organized as a partnership or LLP pays equity partners through K-1 distributions, not a W-2, and the IRS treats partners as self-employed for benefits purposes. That single structural fact changes how a law firm should think about Section 125 savings compared to a retail shop or medical practice where the owner is also on payroll.

The good news is the plan still works. It just works on a smaller, more specific slice of the firm: associates, of counsel attorneys who are W-2 employees, paralegals, legal assistants, and administrative staff. For a firm with a dozen or more people on payroll, that slice is usually enough to make a Section 125 plan worth setting up.

What Is a Section 125 Plan and How Does It Work for a Law Firm?

A Section 125 cafeteria plan is a written benefit plan under Internal Revenue Code Section 125 that lets W-2 employees pay for qualified benefits, such as health insurance premiums, with pre-tax payroll dollars instead of after-tax dollars. The employee's taxable wages drop by the amount of the pre-tax election, which lowers the employee's federal income tax and FICA withholding, and lowers the employer's FICA tax bill by the same 7.65% on the same reduced wage base.

For a law firm, the mechanism is identical to any other employer once you know who qualifies. An associate attorney who elects $450 per month in pre-tax premium contributions reduces her taxable wages by $5,400 per year. The firm never touches her benefit choice, the payroll system applies the deduction before calculating withholding, and the firm's IRS Form 941 FICA deposit drops accordingly. See the full mechanics in our Section 125 cafeteria plan guide.

Can Law Firm Partners Participate in a Section 125 Plan?

No, equity partners in a partnership or LLP cannot participate in the firm's Section 125 plan. The IRS treats a partner as self-employed rather than as an employee for benefits purposes, per Internal Revenue Code Section 125(d)(1)(A) and Treasury Regulation 1.125-1(g), so partner compensation is not W-2 wages and there is no payroll wage base for a pre-tax election to reduce.

This rule surprises firm administrators the first time they price out a plan, because it means the highest earners at the firm, the equity partners, are the ones excluded. It also means a law firm's Section 125 savings math looks different from a typical small business, where the owner usually enrolls alongside everyone else.

Who is eligible depends on how each person is paid, not their title:

Equity partners (K-1 income): not eligible
Non-equity or income partners paid as W-2 employees: eligible
Of counsel attorneys on the firm's W-2 payroll: eligible
Associates: eligible
Paralegals, legal assistants, and administrative staff: eligible
Firm owners structured as an S-corp who own more than 2% of the company: not eligible, the same restriction that applies to S-corp shareholders generally, covered in our Section 125 guide for S-corp shareholders

A firm organized as a professional corporation rather than a partnership should confirm with its accountant whether attorneys are paid as W-2 employees or as shareholders, since the answer changes eligibility.

Summit Health Benefits maps your firm's payroll structure before you commit to anything. We identify exactly which attorneys and staff qualify for pre-tax treatment and model the real savings for your firm's W-2 headcount. Get a free eligibility review.

How Much Can a Law Firm Save With a Section 125 Plan?

A law firm's FICA savings scale with W-2 headcount, not total attorney count. Employers typically recapture $91 to $136 per enrolled employee per month in FICA taxes, according to standard IRS FICA rates of 7.65% applied to pre-tax elections.

Take a 20-person firm with 4 equity partners and 16 W-2 employees, a mix of associates, paralegals, and staff. The 4 partners are excluded. The 16 W-2 employees enrolling in the plan generate $1,456 to $2,176 per month in employer FICA recapture, or roughly $17,472 to $26,112 per year, before fees.

Summit Health Benefits administers Section 125 plans for a flat $35 per enrolled employee per month. For the 16 enrolled employees, that is $6,720 per year in fees, funded from the reduced IRS Form 941 FICA deposit rather than operating cash. Net employer benefit after fees runs $10,752 to $19,392 per year for this firm, and enrolled employees typically take home $70 to $110 more per month because their taxable wages drop. The full FICA mechanics, including how the employer-side savings are calculated line by line, are in our FICA tax savings breakdown.

Does a Section 125 Plan Trigger Nondiscrimination Testing for Law Firms?

Yes, and law firms should pay closer attention to this than most employers because excluding equity partners changes who counts as highly compensated among the remaining W-2 group. A Section 125 plan must pass IRS nondiscrimination testing to keep its tax-favored status for everyone, not just the highest earners.

The IRS runs three tests. The eligibility test checks that the plan does not exclude too many non-highly compensated employees. The contributions and benefits test checks that highly compensated employees do not receive disproportionately richer benefits. The key employee concentration test caps the value of benefits going to key employees at 25% of total plan benefits.

For 2026, the IRS sets the highly compensated employee threshold at $160,000 in prior-year compensation. Because equity partners are already excluded as non-employees, a firm's key employee test usually runs against senior associates, non-equity partners on W-2, and firm administrators earning above that threshold, a smaller and different group than the partnership as a whole. Firms with several high-earning non-equity partners on payroll should run the concentration test carefully before finalizing plan design. Our nondiscrimination testing guide walks through how each test is calculated and what to do if a firm fails one.

What Benefits Can a Law Firm Offer Through a Section 125 Plan?

Most firms start with a Premium Only Plan, which converts existing health, dental, and vision premium deductions from after-tax to pre-tax with no new benefits required. If your W-2 staff already carries group coverage, a Premium Only Plan creates savings with minimal administrative change.

Firms that want to go further can add a Health Flexible Spending Account, capped at $3,400 per employee for 2026 under IRS rules, or a Dependent Care FSA for staff with childcare expenses. Both reduce taxable wages the same way premium elections do. Paralegals and administrative staff, who often carry family coverage on tighter budgets than attorneys, tend to see the largest proportional take-home gain from these accounts.

How Does a Law Firm Set Up a Section 125 Plan?

Setup runs in four steps once you know your eligible headcount. First, confirm which attorneys and staff are paid as W-2 employees versus K-1 partners or S-corp shareholders above 2% ownership. Second, choose plan design, typically a Premium Only Plan alone or paired with an FSA. Third, run the nondiscrimination tests against your actual eligible group before the plan year starts, not after. Fourth, configure payroll deduction codes so pre-tax elections reduce W-2 Boxes 1, 3, and 5 correctly from the first payroll cycle.

Most firms complete setup in under a month when the eligible group is already identified. Firms weighing alternatives to a full group plan, including for associates who prefer individual coverage, should also review our guide to small business health insurance alternatives.

Frequently Asked Questions

Can equity partners at a law firm use a Section 125 plan?

No. Equity partners in a partnership or LLP are paid through K-1 distributions and are treated as self-employed by the IRS, not as W-2 employees. Section 125 only applies to employee wages, so there is no wage base for a partner's pre-tax election to reduce.

Which law firm employees are eligible for a Section 125 plan?

Any attorney or staff member paid as a W-2 employee qualifies, including associates, of counsel attorneys on payroll, non-equity partners paid as employees, paralegals, legal assistants, and administrative staff. Equity partners and S-corp owners holding more than 2% of the firm are excluded.

How much does a law firm save with a Section 125 plan?

A firm typically recaptures $91 to $136 per enrolled W-2 employee per month in FICA taxes. A 20-person firm with 16 eligible employees can net $10,752 to $19,392 per year after a standard $35 per employee monthly administration fee, based on IRS FICA rates of 7.65%.

Does excluding partners cause a law firm to fail nondiscrimination testing?

Not automatically. Excluding partners is required by law, not a plan design choice, so it does not itself cause a failure. However, firms should still run the eligibility, contributions and benefits, and key employee concentration tests against the remaining W-2 group, since senior associates or non-equity partners earning above the 2026 highly compensated threshold of $160,000 can still concentrate benefits if the plan is not designed carefully.

Can a firm offer a Section 125 plan to some offices and not others?

Yes, as long as the plan document defines eligible employee classes consistently and the classes do not discriminate in favor of highly compensated employees. Multi-office firms commonly enroll all W-2 staff firm-wide under one plan document to keep administration simple.

What is the 2026 Health FSA contribution limit for law firm employees?

The IRS caps Health FSA contributions at $3,400 per employee for plan years starting on or after January 1, 2026. This limit applies per employee, not per firm, and stacks with any pre-tax premium elections made through the same Section 125 plan.

How long does it take a small law firm to set up a Section 125 plan?

Most firms complete setup in under a month once the eligible W-2 group is confirmed. The process covers plan document drafting, nondiscrimination testing against the actual eligible group, and payroll deduction configuration before the first pre-tax payroll runs.

Ready to see what your firm's associates and staff could save? Summit Health Benefits models your exact W-2 headcount before you commit to anything.

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Sources: Internal Revenue Service (Section 125 rules, FICA rates, 2026 Health FSA contribution limits, highly compensated employee threshold), Internal Revenue Code Section 125(d)(1)(A), Treasury Regulation 1.125-1(g).