Nondiscrimination Testing

Ensure Compliance with IRS Regulations

In order to qualify for tax-favored status, a benefit plan must not discriminate in favor of highly compensated employees (HCEs) and key employees with respect to eligibility, contributions, or benefits. The Federal government has established regulations that specify requirements for each type of benefit plan governed by IRC Section 125, IRC Section 105, and IRC Section 129. In order to qualify for compliance, annual tests must be performed and the results documented for each benefit plan. The results are subject to audit by the IRS. American Benefits Group offers a comprehensive process for executing these tests.

Key Employees

A Key Employee is one who in the prior plan year* met one or more of these criteria:

An officer of the company earning $185,000 or more annually in 2021; $200,000 in 2022;
A 1% owner (or his/her spouse or dependent) with a salary of $150,000 or more; and,
A 5% (or more) owner, regardless of salary.

*If your plan is in its first year, use the current plan year for determining Key Employees.

Highly Compensated Employees

The Plan may not favor Highly Compensated Employees (HCEs). An HCE is defined as:

An officer in the prior year;
A 5% (or greater) shareholder in the current or prior year;
An employee paid $130,000 in 2021 or $135,000 in 2022
An employee whose salary is in the top 20% of all employees.

Resources

How Can You Prevent Discrimination Problems?
Nondiscrimination Testing Guide
Please complete our Nondiscrimination Testing Request Form and email it to ndx@amben.com.

Did you know that if you have a Premium Only Plan (POP), it is also subject to Nondiscrimination Testing? Visit our POP page for more information.

FAQs

What is nondiscrimination testing?

Each year, the IRS requires companies with pre-tax reimbursement accounts to complete nondiscrimination testing. Nondiscrimination testing ensures that the business owners and Highly Compensated Employee(s) (HCE) do not receive a disproportionate benefit from a pre-tax plan compared to other employees.

Why is verifying my employee census important?

The online census verification process ensures that we have complete and accurate data in order to complete the nondiscrimination testing required by the IRS.

If you do not verify your census, your nondiscrimination tests may be based on inaccurate data, and this could mean that Highly Compensated Employees might receive erroneous or unnecessary refunds.

Please ensure the following information is correct on our retirement plan recordkeeping system:

All employees who received compensation during 2012 who are not explicitly excluded from the plan (per Section 14 of the Adoption Agreement) have been reported.
Each employee’s gross compensation, deferrals, actual hours worked, employment status, and employer contribution match your payroll records.
Highly Compensated Employees are identified.
Employee ownership is identified.

Which employees must be included in the nondiscrimination testing?

All “eligible employees” who received compensation during 2012 are included in nondiscrimination testing, even those who might have terminated employment during the year. Per Section 14 of the Adoption Agreement, generally only union employees, non-resident aliens, leased employees and independent contractors can be excluded from nondiscrimination testing because they are not considered “eligible employees.”

Please include all employees even those who have not met your plan’s age and service requirements.

We will review your plan’s age and service requirements as part of the testing process.

Are there any exceptions to the FSA nondiscrimination testing for small plans?

No. Neither Section 105(h) nor Section 125 provides for a specific size plan. Thus, any-sized self-insured plan, such as an FSA, is subject to Section 105(h) nondiscrimination testing, and any-sized cafeteria plan is subject to Section 125 nondiscrimination testing.

For a discriminatory FSA, where are the excess reimbursements actually reported?

The discriminatory amounts (i.e., the excess reimbursements) are included in the HCIs’ gross income and should be reported on Form W-2, Box 1. If the plan year has already closed and W-2s have already been issued, then the employer must issue amended Form W-2s to the HCIs who received excess reimbursements, and those HCIs would be responsible for filing an amended individual federal income tax return to correct their gross income reported to the Internal Revenue Service (IRS) (assuming the individuals already filed such a return).

What health FSA plan designs may be used to pass the eligibility test?

One plan design that would likely pass the eligibility test would be for the employer to make “seed contributions.” Sponsors can design health FSAs to make a de minimis benefit available to all non-excludable employees (sometimes called a “seed contribution”). If the employer makes a seed contribution, then all these employees would be counted as “benefiting” for eligibility testing purposes. However, making seed contributions would also cause all eligible employees to be participants and might increase aggregate administration costs. In addition, depending on the amount of the seed contribution, the FSA may become subject to obligations under the HIPAA portability rules (it may not be an excepted benefit under these rules) and additional COBRA obligations (it will not be eligible for the special limited COBRA obligation). So keep that in mind.

Employers: Lines of Service