Employers that sponsor a cafeteria plan and certain other health and welfare plans need to be aware of the requirement for non-discrimination testing. Non-discrimination testing is done to ensure that a plan does not favor highly compensated employees or key employees. With regard to non-discrimination testing these employees become a “prohibited group”, in other words, the plan cannot favor the prohibited group. Employees who are part of the prohibited group will be defined differently depending on the type of plan that is being tested.
There are various types of plans that require non-discrimination testing mandated by various internal revenue codes:
- IRC §125 – Cafeteria plan rules (1978, amended 1984)
- IRC §105(h) – Self-insured medical rules/health FSA (1978)
- IRC §129 – Dependent care assistant program rules (1981)
- IRC §79 – Group term life rules (1982)
Therefore, as a plan sponsor, if you sponsor a plan that falls under one of the above IRC codes, the plan will be subject to non-discrimination testing.
There are three components to non-discrimination testing. The first test is for eligibility and looks at which employees are eligible to participate in the plan. This part of the test does not look at who actually participates in the plan, but takes into account all those who could participate if they chose to. The second part of the test is the benefits test. The benefits test looks at what employees get what benefits. The third component of non-discrimination testing is utilization. This component looks at who is actually choosing to participate in the benefits that are offered. The tests are both objective and subjective and use mathematical formulas as well as facts and circumstances.
Non-discrimination testing must be performed as of the last day of the plan year. Testing is performed prior to the start of the plan year in order to predict and anticipate whether or not the plan will favor a prohibited group. Testing done mid plan year is completed in an effort to assess and correct plans that may favor a prohibited group. Testing performed at the close of the plan year is done to document and assess what occurred during the plan year and to show that prohibited groups were in no way favored in the plan design.
Prior to the Affordable Care Act, it was not required that fully-insured plans perform non-discrimination testing. That changed under health care reform, though IRS Notice 2011-11 delayed the expansion of testing until further notice is provided.
The above information will be the first in a series of HR Clinics that explain non-discrimination testing. Additional HR Clinics over the next several months will cover the specifics of non-discrimination testing for:
- Self-Insured/Health FSA non-discrimination testing
- DCAP non-discrimination testing
- Group term life non-discrimination testing
With regard to each type of plan mentioned above, the following will be discussed:
- Specific tests required for the plan
- Definitions of prohibited groups for the plan
- Tested groups for the plan
- Excluded employees for the plan
- Consequences of a discriminatory plan
Additionally, we will address things to consider when looking at plan design. Please be on the lookout for these additional HR Clinics to be distributed on or around the 30th of July, August and September.
Source: HR Workplace Services