Nondiscrimination Testing for Cafeteria Plans and Health and Welfare Benefit Plans
The Internal Revenue Code ("IRC") and related Regulations require that a "cafeteria" or 125 plan and certain health and welfare benefit plans undergo annual nondiscrimination testing to ensure that, in general, they do not discriminate in favor of highly compensated employees, highly compensated individuals and/or key employees (as these terms are defined in the IRC). Specifically, the health and welfare benefits subject to this annual testing are dependent care assistance programs, group term life insurance plans, and self-insured medical reimbursement plans, which include but are not limited to any self-funded health, dental, vision, short term disability and long term disability plans as well as a health flexible spending account ("Health FSA") ("Self-Insured Plans"). In addition, although no Regulations have been released from any federal agency finalizing this requirement, it is important to remember that the Patient Protection and Affordable Care Act ("PPACA") contains a provision that, if and when it becomes effective, will require all fully-insured medical reimbursement plans ("Fully-Insured Plans") to comply with the IRC Section 105(h) nondiscrimination requirements, as well.
These tests apply to any and all employers, whether for-profit, non-profit, governmental or a "church." Besides a limited narrow exception for certain "churches" from the group term life nondiscrimination requirements, there are no other exceptions from any of these IRC nondiscrimination requirements, unlike the Employee Retirement Income Security Act of 1974 ("ERISA"), which excepts certain types of employers from ERISA compliance. Accordingly, if you are an employer that sponsors a cafeteria plan and/or any of the health and welfare benefit plans listed above, you must perform the required nondiscrimination testing for any such plans on an annual basis.
Risks to Employees and Employers
If you fail to perform nondiscrimination testing for your cafeteria plan or health and welfare benefit plans, you will lose your ability to correct any discriminatory issues that may exist. Failing to correct any issues and later uncovering (likely through an audit) that your plans are discriminating in favor of highly compensated employees, highly compensated individuals, or key employees, as applicable, will result in all or a portion of the benefits provided to these individuals being deemed taxable and included in such individuals’ gross income. If such discrimination is uncovered, both the employee and employer will be subject to additional taxes on the amount of certain benefits and interest and penalties may also be assessed.
Further, in light of the looming provision contained in the PPACA that will effect employers sponsoring Fully-Insured Plans as stated above, we believe it is critical that your plans demonstrate compliance with the existing nondiscrimination rules before this new provision becomes effective and compliance with all of the IRC nondiscrimination rules garners the attention of the federal government, possibly making cafeteria plan and health and welfare benefit plan audits more commonplace.
Recommendations for Employers
We recommend that your organization analyze all of the plans and programs it sponsors to determine which should be undergoing nondiscrimination testing. Further, even if you are currently performing such testing, we urge you to ensure that such testing is:
1) Being performed for all the applicable plans you sponsor,
2) Being performed on an annual basis, and
3) Being performed correctly and in accordance with the IRC and corresponding regulations.
For example, although your Third Party Administrator ("TPA") may be completing the IRC Section 125 tests for your cafeteria plan, it is likely not also testing any of your Self-Insured Plans under IRC Section 105(h). In addition, upon reviewing some IRC Section 125 tests performed by certain TPAs, we found them to be incorrectly performed. In a few cases, we found that the amount of participants' Health FSA annual elections were solely taken into account for certain tests, where the tests actually require that the total annual premium amount for all benefits offered under the cafeteria plan be used.
If your organization sponsors a cafeteria plan under IRC Section 125, a dependent care assistance program under IRC Section 129, a group term life insurance plan under IRC Section 79 and/or any Self-Insured Plans under IRC Section 105(h) and you are not performing nondiscrimination testing for some or any of these plans or programs, Findley Davies has the expertise to assist and perform such testing in an efficient manner. Further, if any of your plans or programs are found to be discriminatory, it is imperative to establish and implement correction methods, including possible plan re-design, to position the plans or programs to avoid the issue or at the very least, minimize the impact. Not only can Findley Davies perform the nondiscrimination testing for your plans, we can help correct any issues in the event discrimination is found. In addition, in light of the forthcoming PPACA requirement, Findley Davies can analyze and test prospectively any of your Fully-Insured Plans to prepare you for any possible discrimination that may exist within such plans.
Please contact us and we would be happy to assist you.