Question

Exactly which employer sponsored plans are subject to 'nondiscrimination testing'?

Answer

There are four key IRS nondiscrimination rules that apply to health and welfare benefits:

• IRC §125 applies to any benefits included in an employer’s cafeteria plan, including premium only plans (POPs). For purposes of testing under §125 nondiscrimination rules, all benefits available through the employer’s cafeteria plan are aggregated.
• IRC §129 applies to dependent care assistance programs (DCAPs).
• IRC §105(h) applies to self-funded and level funded group health plans, including medical, dental, vision, health reimbursement arrangements (HRAs), and health flexible spending arrangements (FSAs).
• IRC §79 covers group term life insurance. Compliance with §79 allows the first $50,000 in coverage to be available on a tax-favored basis.

Some plans must comply with multiple nondiscrimination rules. For example, a self-funded group health plan offered through an employer’s cafeteria plan, allowing employees to make pre-tax contributions, is subject to both §125 and §105(h) nondiscrimination requirements.

What Happens If the Plan is Discriminatory?

If a benefit plan is discriminatory under IRS rules, highly compensated or key employees who participated in the plan may lose the tax advantage associated with those benefits, resulting in additional income taxes for the participants and additional payroll taxes for the employer. To avoid this result, action must be taken prior to the end of the plan year to adjust the level of tax-advantaged benefits provided to highly compensated or key employees.

Additional Sources

• Section 125 Nondiscrimination Rules and Testing
• Section 105(h) Nondiscrimination and Testing
• 26 U.S. Code Section 125 - Cafeteria Plans
• Health & Welfare Benefit Nondiscrimination Rules

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