When is Nondiscrimination Testing on a Cafeteria Plan Required?

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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 who own or are in charge within an organization. All employers regardless of business type or size are required to perform annual nondiscrimination tests or hire a third party to conduct testing on their plan.  Employee Benefits Corporation includes nondiscrimination testing for our BESTflex, BESTflex Self-Administration and BESTflex Premium Only Plan clients as part of our standard service agreements.

Nondiscrimination testing typically occurs during the 4th quarter of the plan year because the IRS requires that the tests pass as of the last day of the plan year. For employers who offer calendar year plans, a request for information will go out in September due to the volume of calendar year testing performed between October and December. At this point in the plan year, the employer has a majority of the data needed in testing and can project much of the outstanding data. In addition, many of the new hires from the plan year can be included. Running the test at this time is a good way to determine if there are any red flags indicating that the plans will not pass. Employers can also make adjustments in order to reduce their chance of a plan failure, and taxation to their highly compensated employees. Once the plan year is over, no further adjustments are permitted, and any failures will result in taxable income for highly compensated and/or key employees.

As open enrollment season gets into full swing and calendar year plans are approaching 4th quarter, we thought it would be helpful to provide answers to some of the more frequently asked questions regarding the required annual nondiscrimination testing.

What is the purpose of nondiscrimination testing?

The IRS requires that all employers that offers a cafeteria plan (or in other words, a pre-tax benefit plan) must perform various nondiscrimination tests on the plan annually and have passing results as of the last day of each plan year. In other words the plan cannot favor highly compensated and/or key employees.

How many tests are required if the cafeteria plan includes premiums and flexible spending accounts?

The number of tests required is determined by which plan types are included in the cafeteria plan:

2 tests per self-funded health plan (e.g. Health Care FSA)

  • Eligibility Test
  • Benefits Test

4 tests per Dependent Care FSA

  • Eligibility Test
  • Contributions and Benefits Test
  • 55% Average Test
  • 25% Owner Concentration Test

3 tests per Cafeteria Plan (Premium only plans and those that include FSAs)

  • Eligibility Test
  • Contributions and Benefits Test
  • 25% Concentration Test (Key Employee Test)

I am an employer with less than 100 employees, do I need to do this?

Yes. All employers that sponsor a cafeteria plan, regardless of the number of employees or participants are required to test their cafeteria plan.

I am a governmental entity (i.e. public school district) or church plan that is not subject to ERISA and do not file a Form 5500. Do I need to do this?

Yes. All employers that sponsor a cafeteria plan are required to test their cafeteria plan annually. There is no exception for governmental entities and church plan.

We only sponsor a Premium Only plan. Is nondiscrimination testing required?

Yes. The Premium Only plan is a cafeteria plan subject to annual nondiscrimination testing. The testing is not as extensive when only premiums are involved.  The IRS guidance allows these plans to skip the Concentration and Benefits Test and 25% Concentration Test if they pass the Safe harbor Eligibility Test.

When is the testing due?

Nondiscrimination testing is required as of the last day of the plan year. Many employers test prior to the end of the plan year to allow time to make changes to the elections before the end of the plan year. No changes to elections are permitted after the last day of the plan year, which may result in imputed income which is taxable for the highly compensated and/or Key Employees affected by any testing failures.

What happens if an employer does not do the required annual nondiscrimination testing?

If the IRS audits the cafeteria plan, they will likely request copies of testing results or even the actual test to determine that you have performed and passed the nondiscrimination tests for each year they are auditing. Failure to provide testing results may result in plan disqualification which could lead to tax penalties for the employer and participants.

Who performs the nondiscrimination testing on the cafeteria plan? 

Annual nondiscrimination testing would be the employers’ responsibility unless the employer has contracted with a third party to perform the required tests.

Note: Employee Benefits Corporation includes nondiscrimination testing service for employers with our BESTflex, BESTflex Self-Administration and BESTflex Premium Only Plans, and for those that have contracted for stand-alone testing under Compliance Services. Annually the employers provide details regarding owners, officers, highly compensated individuals, family members related to owners, officers and highly compensated individuals and a complete listing of non-highly compensated employees that is used to perform the required annual nondiscrimination testing. Upon receipt of the requested data, we are able to perform the necessary tests and notify the employer of the results. In the event of a testing failure, we identify which individuals are impacted by the failure and the employer will work with their payroll provider or tax advisor to make any changes to the plan or report any required imputed income.

Want to learn more about Nondiscrimination Testing?

Employee Benefits Corporation will be hosting two “Fundamentals of Nondiscrimination Testing” webinars in September. Click here to register!

 

 

Categories: Benefits in General, Compliance, Health Care in General | Tags: IRS , Nondiscrimination Testing , NDT , Key Employees , Highly Compensated Employees , Non-Highly Compensated Employees , Flexible Spending Account , FSA , Premium , Cafeteria Plan | Return