If you have a Flexible Spending Account (FSA), IRS requires you to submit to nondiscrimination testing once a year. The reason for nondiscrimination testing is to prevent Key and highly compensated employees from taking advantage of these plans’ benefits for employers and employees. Such advantages include an increase in take-home pay because the dollars spent are pre-tax and a 7.65% annual savings on employers matching FICA tax.
Suppose your company offers any form of a pre-tax welfare benefits plan such as group Medical, Dental, Vision or Life insurance (commonly referred to as a Premium Only Plan or POP) or a Flexible Spending Account (widely referred to as an FSA or Cafeteria Plan). In that case, an IRS requirement is to test your benefit plan for Nondiscrimination annually. These tests are designed to ensure that the company treats all of its employees relatively in regards to their benefits package and not giving employees who are higher paid or in management positions better benefits than their lower-paid or non-management employees.
Depending on what type of benefits your company offers, up to nine tests may need to be administered. Some tests are related to eligibility and availability of benefits, and some are based on how many employees have elected these benefits. Below is a list of required tests for companies’ most common benefits packages: 105(h) Nondiscrimination Testing.
Benefits under an employer-sponsored health plan generally are not taxable due to a particular section of the Code, which excludes the value of those benefits from taxation. However, to ensure that employers do not improperly discriminate in favor of Highly Compensated Individuals (“HCIs”), Congress created nondiscrimination rules under Code Section 105(h). Code Section 105(h) currently only applies to self-funded health plans. A plan is generally treated as self-funded, even if the plan has stop-loss insurance. Also, the Affordable Care Act (“ACA”) provides that non-grandfathered, fully insured health plans will also be subject to rules “similar” to Code Section 105(h).
The 105(h) Test is designed to verify two things. First, “enough” non-HCIs “benefit” under the health plan in comparison to the number of HCIs who “benefit.” Second, to verify that the health plan’s benefits (e.g., deductible levels and covered benefits) do not favor HCIs.
Health FSA Tests
- Health FSA Eligibility Test: Under the Health FSA Eligibility Test, a plan may not discriminate in favor of HCIs regarding participation eligibility. A plan may satisfy any of these three sub-tests to pass:
- Subtest #1: The plan benefits 70% of all non-excludable employees.
- Subtest #2: The plan benefits 80% or more of all non-excludable employees who are eligible to benefit if 70% or more of all non-excludable employees are eligible to benefit under the plan.
- Subtest #3: Nondiscriminatory Classification Test. Safe Harbor and Unsafe Harbor Percentage Tests.
- Health FSA Benefits Test: Under the Health FSA Benefits Test, a plan may not discriminate in favor of HCIs, and all participants should benefit from the plan the same way as HCIs.
Types of Testing
- Section 125 Premium Only Plan (POP) /Cafeteria Plans – Including HSAs
- Eligibility Test
- Contributions and Benefits Test
- Key Employee Concentration Test
- Health FSAs and Dependent Care FSA (DCAP)
- All tests under POP listed above are Benefits Test (FSA only) Contribution and Benefits Test (DCAP only)
- More – Than – 5% Owners Test (DCAP only)
- 55% Average Benefits Test (DCAP only)
- Section 105(H) Self-Insured Medical Plans and HRAs Eligibility Tests
- 70% Test
- 70/80% Test
- Benefits Test