Non Discrimination Testing
If you have a Flexible Spending Account (FSA) IRS requires you to submit to non discrimination testing once a year. The reason for non-discrimination testing is to prevent Key and highly compensated employees from taking advantage of the benefits that these plans provide for employers and employees alike. Such advantages consist of an increase in take-home pay because the dollars spent are pre-tax and a 7.65% savings annually on employers matching FICA tax.
If 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 (commonly referred to as an FSA or Cafeteria Plan), there is an IRS requirement to test your benefit plan for Non-discrimination on an annual basis. These tests are designed to make sure that the company is treating 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, there are up to nine different tests that 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 tests that are required for each of the most common benefit packages companies offer: 105(h) Nondiscrimination Testing.
Benefits under an employer-sponsored health plan generally are not taxable due to a special 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). Currently, Code Section 105(h) 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, that “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 as to eligibility to participate. A plan may satisfy any of these three sub-tests in order 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 be benefiting from the plan in the same way as HCIs.
Types of Testing
- 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)