What is Annual Compensation for Purposes of Cafeteria Plan Nondiscrimination Testing?

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Background: The nondiscrimination tests are a series of tests that are required by the Internal Revenue Service (IRS) to determine if a cafeteria plan that includes benefits like a health care flexible spending account (HCFSA), dependent care flexible spending account (DCFSA), pre-tax premiums under a cafeteria plan unjustly favor higher-paid individuals or those in charge within an organization. Employers are required to perform annual nondiscrimination tests unless they hire a third party to conduct testing on their plan.  Employee Benefits Corporation provides nondiscrimination testing for our clients as part of our service arrangements.

Annual compensation: For purposes of the cafeteria plan nondiscrimination testing, the employer will use gross annual compensation which includes all taxable wages the employee receives from the employer, adds back any pre‐tax benefits the employee elects, as well as adds any taxable benefits the employee receives.

How do you calculate annual compensation?

For this purpose, the employer should use gross annual compensation which includes all taxable wages the employee receives from 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

As a reminder, a 2018 Highly Compensated Employee is anyone earning $120,000 or more in the prior year.

Which time period do you use to determine Annual Compensation?

Calendar year plans use the prior calendar year. For a new hire it would be calculated as estimated gross annual compensation for the current calendar year.  See examples below.

Example: Calendar plan year ending December 31, 2018:

  • Employee hired prior to start of plan year January 1, 2018
    • Report gross annual compensation for January 1, 2017 to December 31, 2017
  • Employee hired prior to start of plan year January 1, 2018, but terminates sometime in 2018
    • Report gross annual compensation for January 1, 2017 to December 31, 2017
  • Employee hired after start of plan year January 1, 2018 on January 15, 2018 and is still actively employed.
    • Report a projection of estimated gross annual compensation from hire date to December 31, 2018
  • Employee hired after start of plan year January 1, 2018. For example hired on January 15, 2018 and terminated in 2018 on June 12, 2018 before the plan year ends.
    • Report actual gross annual compensation as year-to-date total from hire date January 15, 2018 to termination date June 12, 2018

Non-calendar year plans may either be calculated as gross annual compensation during the prior plan year or gross annual compensation for the calendar year ending during the plan year. Non Calendar year plans may report by using either 1) the Preferred Method or the 2) Alternative Method.  See examples below.

Example: Non‐calendar plan year ending October 31, 2018:

Preferred method – report gross annual compensation looking back to prior plan year

  • Employee hired prior to November 1, 2017
    • Report gross annual compensation for November 1, 2016 to October 31, 2017
  • Employee hired after November 1, 2017 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 November 1, 2017 and is still actively employed
    • Report estimated gross annual compensation from hire date to end of plan year October 31, 2018

Alternative method – look back to prior tax year that ended during the current plan year

  • Employee hired prior to January 1, 2018
    • Report gross annual compensation for January 1, 2017 to December 31, 2017
  • Employee hired after January 1, 2018 and terminated employment already
    • Report actual gross annual compensation from hire date to termination date
  • Employee hired after January 1, 2018 and is still actively employed
    • Report estimated gross annual compensation from hire date to December 31, 2018

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.

The Bottom Line

All employers are required to perform cafeteria plan nondiscrimination testing regardless of employer size or business type. There is no governmental or church plan exception for testing. Employee Benefits Corporation provides nondiscrimination testing services for our clients to assist them with the required plan compliance.

 

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