Section 125 Plans and Remote Employees: Does It Work Across State Lines?

A Section 125 plan cuts federal FICA and income tax the same way no matter where an employee lives, but state income tax treatment is not always identical. Here is what a multi-state employer needs to check.

Quick Answer (as of 2026): A Section 125 cafeteria plan cuts federal income tax and the 7.65% FICA rate by the same amount for every employee, no matter which state they work from, because both are federal taxes set by the Internal Revenue Code. State income tax treatment of the same pre-tax election can differ by state, so an employer with remote staff in multiple states should confirm each state's rule before finalizing payroll setup.

A Section 125 plan for remote employees works the same way it does for an office-based team on the federal side of the paycheck. The plan lets an employee pay for health insurance, dental, vision, or a Flexible Spending Account with pre-tax dollars, which lowers their federal taxable wages and cuts the employer's FICA bill by 7.65 cents on every pre-tax dollar. That part of the math does not change based on a ZIP code.

What can change is the state income tax side. Most states follow the federal government's treatment of Section 125 elections, but not every state applies the same rule the same way, and an employer running payroll in five or six states for a fully remote team needs to know the difference before open enrollment, not after a payroll audit.

What Is a Section 125 Plan, Briefly?

A Section 125 cafeteria plan is an IRS-approved arrangement, named for Internal Revenue Code Section 125, that lets a W-2 employee choose to pay for qualified benefits with pre-tax salary dollars instead of after-tax dollars. The most common version is a Premium Only Plan, which applies just to health insurance premiums. For a full walkthrough of how the plan works, see our <a href="/blog/section-125-cafeteria-plan-2026-guide">Section 125 cafeteria plan guide</a>.

Does a Section 125 Plan Save the Same FICA Amount No Matter Where an Employee Lives?

Yes. FICA is a federal payroll tax, 6.2% for Social Security and 1.45% for Medicare, 7.65% combined on the employer side, and it applies identically in every state. A Section 125 election reduces the wages FICA is calculated on by the same dollar amount whether the employee logs in from Ohio, Texas, or California. An employer with a 40-person remote team electing an average of $200 per month in pre-tax benefits saves the same $306 per month in employer FICA, or $3,672 per year, regardless of how many states that team is spread across. For the full calculation, see our <a href="/blog/maximizing-fica-tax-savings">FICA tax savings breakdown</a>.

Federal income tax withholding works the same way. The Internal Revenue Code sets the exclusion nationwide, so a remote employee's federal taxable wages drop by the same pre-tax election amount no matter which state issues their driver's license.

Does Every State Tax Section 125 Elections the Same Way as the Federal Government?

Most do, but an employer should not assume every state automatically mirrors the federal rule without checking. Most states calculate state income tax starting from federal adjusted gross income or federal taxable wages, which means a Section 125 pre-tax election that lowers a W-2's Box 1 wages generally lowers state taxable wages too, without any separate state-level election.

Pennsylvania is a state employers often worry about unnecessarily. Under guidance from the Pennsylvania Department of Revenue, employee contributions to a qualified IRC Section 125 cafeteria plan for health, dental, and vision coverage are excludable from Pennsylvania taxable compensation, the same as the federal exclusion, as long as the plan is a properly qualified Section 125 plan. New Jersey follows the same approach for employer-sponsored health coverage paid through a Section 125 plan, under N.J. Rev. Stat. Section 54A:6-24, which excludes qualifying cafeteria plan contributions from New Jersey gross income. Both states have a reputation for complicated payroll tax rules, so confirming they conform on this specific point is useful news for an employer with remote staff in either one.

The practical takeaway is not that every state is guaranteed to match the federal treatment on every type of benefit inside a Section 125 plan. Dependent Care FSA and Health FSA elections can follow slightly different state rules than premium-only elections in some jurisdictions. An employer running payroll in a new state for the first time should confirm the treatment with that state's revenue department or its payroll provider before assuming the federal exclusion carries over automatically.

Summit Health Benefits sets up your Section 125 plan for a multi-state team correctly the first time. We confirm how each state where you have remote employees treats pre-tax elections and configure your plan documents accordingly. Get a free multi-state payroll review.

How Do State Reciprocity Agreements Affect Section 125 Payroll for Remote Employees?

A reciprocity agreement lets a remote employee who lives in one state and is legally based in another for payroll purposes pay income tax to only their home state, instead of filing in both. Pennsylvania and New Jersey have run a reciprocal personal income tax agreement since 1977, so a Pennsylvania resident whose employer is based in New Jersey generally owes New Jersey no state income tax withholding at all, and the reverse is also true. Roughly 30 states participate in some form of reciprocity arrangement with at least one neighboring state.

A Section 125 election still reduces taxable wages correctly under a reciprocity agreement, since the pre-tax reduction happens before state withholding is calculated for whichever state actually collects the tax. The complexity is administrative, making sure payroll withholds for the correct state, not whether the Section 125 savings apply. An employer unsure whether a specific remote hire falls under a reciprocity agreement should confirm with its payroll provider before the employee's first paycheck.

Does a Section 125 Election Affect State Unemployment Insurance Wages?

In most states, yes, in the same direction as FICA. State unemployment insurance, sometimes called SUTA, is generally calculated on a wage base that follows the same federal wage definition Section 125 already reduces, so a lower FICA-taxable wage typically means a lower SUTA-taxable wage in the same state as well. The SUTA wage base cap and tax rate still vary significantly by state and by an employer's own experience rating, so the dollar savings are smaller and less predictable than the FICA savings. An employer with a multi-state remote team should treat any SUTA reduction as a secondary benefit of the plan, not the primary reason to adopt one, and should confirm the specific treatment with each state's workforce agency if the SUTA math matters to their budget.

What Should a Multi-State Employer Check Before Enrolling a Remote Team?

An employer bringing a Section 125 plan to a fully remote or multi-state workforce should confirm four things before open enrollment opens: that the plan document and Summary Plan Description do not restrict eligibility by work location in a way that accidentally excludes remote hires, that payroll is registered correctly in every state where an employee actually works, that any reciprocity agreements relevant to the team are applied correctly so employees are not double-taxed, and that the plan administrator can confirm state-level pre-tax treatment for any state that is new to the company. None of these steps change the federal FICA and income tax savings, which apply uniformly, but skipping them can create a payroll correction months later.

A remote team also spreads out an employer's exposure to <a href="/blog/health-insurance-premium-increase-2026-by-state">rising health insurance premiums, which vary widely by state</a>, so a multi-state employer weighing a fully insured group plan against a <a href="/blog/small-business-health-insurance-alternatives-2026">level-funded or alternative small business plan</a> should factor state-by-state premium differences into that decision alongside the Section 125 payroll questions above.

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Frequently Asked Questions

Does a Section 125 plan save the same amount of FICA tax no matter what state an employee lives in?
Yes. FICA is a federal tax set at 7.65% combined for Social Security and Medicare, and it applies the same way in every state. A Section 125 election reduces FICA-taxable wages by the same dollar amount regardless of where a remote employee is located.
Do Pennsylvania and New Jersey tax Section 125 health insurance elections?
No, not when the plan is a properly qualified Section 125 plan. Pennsylvania excludes employee contributions to health, dental, and vision coverage from state taxable compensation under Pennsylvania Department of Revenue guidance. New Jersey excludes qualifying cafeteria plan health coverage contributions from state gross income under N.J. Rev. Stat. Section 54A:6-24.
What is the Pennsylvania-New Jersey reciprocal tax agreement and does it affect Section 125 payroll?
The agreement, in place since 1977, lets a resident of one state working for an employer based in the other pay income tax only to their home state. A Section 125 election still reduces taxable wages correctly under the agreement, since the pre-tax reduction happens before withholding is calculated for whichever state collects the tax.
Does a Section 125 election reduce state unemployment insurance (SUTA) wages?
In most states, yes, since state unemployment insurance wage bases generally follow the same federal wage definition that Section 125 already reduces for FICA. The dollar impact is smaller than the FICA savings and varies by state wage base cap and by an employer's own experience rating, so employers should confirm the specific treatment with each state's workforce agency.
Do local city or county wage taxes follow the same Section 125 exclusion as state income tax?
Generally yes in jurisdictions where the local tax is calculated from the same state wage base, but local rules vary by city and county and are not guaranteed to match automatically. An employer with remote employees in a locality that levies its own wage tax should confirm the local treatment with its payroll provider rather than assume it mirrors the state rule.
Can a small business with remote employees in five different states offer one Section 125 plan?
Yes. A single Section 125 plan document can cover employees across multiple states, since eligibility is based on W-2 employment status, not work location. The employer still needs payroll registered correctly in every state where an employee works and should confirm each state's specific tax treatment before enrollment opens.
What should an employer check before enrolling a multi-state remote team in a Section 125 plan?
An employer should confirm the plan document does not restrict eligibility by work location, that payroll is registered in every state where employees actually work, that any relevant reciprocity agreements are applied correctly, and that the plan administrator has confirmed state-level pre-tax treatment for any state new to the company. Skipping these steps does not change the federal FICA savings but can create a payroll correction later.

Setting up a Section 125 plan for a remote or multi-state team takes the same five weeks it takes for a single-office employer, the difference is confirming the state-level details up front instead of discovering a gap after the first payroll run. Summit Health Benefits handles that confirmation as part of every multi-state setup, at no cost to review.

See Employer Coverage Options

Sources: Internal Revenue Code Section 125; Pennsylvania Department of Revenue guidance on IRC Section 125 cafeteria plans and taxable compensation; New Jersey Revised Statutes Section 54A:6-24 (Cafeteria plan, qualified option, certain; not gross income); Pennsylvania-New Jersey Reciprocal Personal Income Tax Agreement (in effect since 1977); Social Security Administration and IRS FICA rate schedules (7.65% combined employer rate).