Cafeteria Plan Nondiscrimination Testing: Calculating Annual Compensation

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Background: 

The cafeteria plan nondiscrimination tests are a series of tests that are required annually by the Internal Revenue Service (IRS) to determine if a cafeteria plan unjustly favors higher-paid individuals or those in charge within an organization. Within the cafeteria plan, the IRS specifically looks at a health care flexible spending accounts (HCFSA), dependent care flexible spending accounts (DCFSA), and pre-tax premiums under a cafeteria plan. Employers are required to perform annual nondiscrimination tests or hire a third party to conduct testing on their plan.  Employee Benefits Corporation provides nondiscrimination testing for our BESTflex and BESTflex Premium Only Plan clients as part of our standard service agreements.  Employers who do not have our administration services can contract with us separately under Compliance Services for stand-alone cafeteria plan testing.

How do you calculate annual compensation?

For purposes of the cafeteria plan nondiscrimination testing, the employer typically will use gross annual compensation from either the prior calendar year or the prior plan year, unless the employee is a new hire.  Gross annual compensation includes all taxable wages the employee receives from the employer. In addition, the employer adds back any pre‐tax benefits the employee elects, as well as adds any taxable benefits the employee receives.

The calculation starts with the employee’s taxable (W-2) wages.

  • Add to the W-2 wage, any amounts the employee sets aside pre-tax through payroll deduction benefits
    • Section 125 pre-tax deductions for premiums, flexible spending account and health savings accounts; transportation benefits deducted pre-tax for parking and/or transit; retirement plan deductions (i.e. 401k, 403(b))
  • Additionally, add back any other taxable benefits the employee receives from the employer
    • For example the premium attributed to group term life insurance in excess of $50,000
    • The premium attributed to disability insurance paid by the employer
    • Wellness benefits considered taxable as income
  • Report everyone who was employed at any point during the plan year being tested. This is regardless of their wages or whether or not they were employed for the entire plan year
  • Do not report employees if they were not employed during the plan year being tested
  • The 2020 Highly Compensated Employee income threshold is $125,000 or more in the prior year for some testing
  • The 2020 Key Employee income threshold is $180,000 or more in the prior year for some testing

Which time period do you use to determine Annual Compensation?

Calendar year plans use the prior calendar year for active employees who were employed during the entire plan year being tested. For a new hire annual compensation would be calculated as estimated gross annual compensation for the current calendar year.  See examples below.

Example: Calendar plan year ending December 31, 2020:

Employee hired prior to start of plan year January 1, 2020 and is still actively employed

Report gross annual compensation for January 1, 2019 to December 31, 2019

Employee hired prior to start of plan year January 1, 2020, but terminated sometime in 2020

Report gross annual compensation for January 1, 2019 to December 31, 2019

Employee hired after start of plan year January 1, 2020 (example on January 15, 2020) and is still actively employed

Report a projection of estimated gross annual compensation from hire date in 2020 to December 31, 2020

Employee hired after start of plan year January 1, 2020 and terminated sometime in 2020, before the plan year ends. For example hired on January 15, 2020 and terminated on June 12, 2020.

Report actual gross annual compensation as year-to-date total from hire date January 15, 2020 to termination date June 12, 2020

 

Non-calendar year plans may report using either (1) gross annual compensation during the prior plan year or (2) gross annual compensation for the calendar year ending during the plan year. If you are an Employee Benefits Corporation client and completing the nondiscrimination testing worksheet, the methods above are respectively referred to as the (1) Preferred Method and (2) Alternative Method. See examples below.

Example: Non‐calendar plan year beginning November 1, 2019 and ending October 31, 2020:

Preferred Method – For your active employees who were employed during the entire plan year being tested, report gross annual compensation looking back to prior plan year. For a new hire, the calculations may vary. See examples below.

Employee hired prior to start of plan year November 1, 2019

Report gross annual compensation for November 1, 2018 to October 31, 2019

Employee hired after start of plan year November 1, 2019 and terminated employment already before the end of the plan year

Report actual gross annual compensation from hire date to termination date

Employee hired after start of plan year November 1, 2019 and is still actively employed

Report estimated gross annual compensation from hire date to end of plan year October 31, 2020

 

Alternative Method – For your active employees who were employed during the entire plan year, look back to tax year that ended during the current plan year. In this example, we would be looking at the tax year of 2019 (Dec 31, 2019 is between Nov 1, 2019 and Oct 31, 2020). For a new hire, the calculations may vary. See examples below.

Employee hired prior to start of calendar year January 1, 2020

Report gross annual compensation for January 1, 2019 to December 31, 2019

Employee hired after start of calendar year January 1, 2020 and terminated employment already

Report actual gross annual compensation from hire date in 2020 to termination date

Employee hired after start of calendar year January 1, 2020 and is still actively employed

Report estimated gross annual compensation from hire date to December 31, 2020

 

What if we have a short plan year? How do we report annual compensation?

The same compensation for the short plan year should be calculated as if the plan year was twelve months in duration and ended on the same date. Using the examples above:

  • If you had a short plan year of July 1, 2020 – December 31, 2020, you would treat this the same as if your plan year was January 1, 2020 – December 31, 2020.
  • If you had a short plan year of January 1, 2020 – October 31, 2020, you would treat this the same as if your plan year was November 1, 2019 – October 31, 2020.

The Bottom Line                                             

All employers are required to perform annual cafeteria plan nondiscrimination testing regardless of size or business type. There is no governmental or church plan exception for testing. Employee Benefits Corporation provides nondiscrimination testing services for our BESTflex and BESTflex Premium Only Plan clients to assist them with the required plan compliance. We also offer Nondiscrimination Testing as a Compliance Services offering for employers that do not have any of our noted administration services listed above.  A separate Compliance Services Service Agreement is required.

Categories: Benefits in General, Compliance, Health Care in General | Tags: Cafeteria Plan , Nondiscrimination Testing , NDT , HCFSA , DCFSA , Flexible Spending Account , FSA , IRS , Annual Compensation , Gross Compensation , W-2 | Return

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