The basics of nondiscrimination testing for cafeteria plans

There’s a lot to do as the end of your plan year approaches. One thing that you don’t want to forget about is nondiscrimination testing for your cafeteria plan. Under tax law, cafeteria plans cannot discriminate in favor of highly compensated employees, and the only way to know for sure whether or not your cafeteria plan is nondiscriminatory is to complete nondiscrimination testing. The good news is, Employee Benefits Corporation (EBC) can help with this testing.

What is nondiscrimination testing?

Nondiscrimination testing for cafeteria plans is a series of primarily mathematical tests that determine if a cafeteria plan favors highly compensated employees, owners, officers, or their relatives.

Why should my company conduct nondiscrimination testing?

The primary reason to conduct nondiscrimination testing is to ensure that your company’s cafeteria plan does not discriminate in favor of highly compensated employees for any plan year. If your company does not conduct nondiscrimination testing and the IRS later audits your company’s cafeteria plan and determines the plan was discriminatory, your company’s cafeteria plan could lose its tax benefits with respect to participants that are highly compensated or key employees.

Does my company have to conduct nondiscrimination testing each year?

The safest approach is to complete nondiscrimination testing for every plan year so you can be confident that your plan doesn’t discriminate in favor of highly compensated employees. Failure to complete nondiscrimination testing for each plan year might have negative tax consequences as described above. Many employers choose the safest approach of annual nondiscrimination testing because it provides assurance that their plans are being operated in compliance with the nondiscrimination rules.

That said, some employers choose a more aggressive approach and skip nondiscrimination testing some years, especially if the employer’s plan recently passed nondiscrimination testing and the employer believes it’s unlikely their test results will change significantly from year-to-year. Employers using this more aggressive approach may choose to conduct subsequent testing if the employer experiences material workforce changes or has other significant business changes.

Do nondiscrimination testing results get sent to the IRS?

No. You are not required to send your company’s results to the IRS. However, if the IRS were to audit your company’s cafeteria plan and request copies of your company’s nondiscrimination testing results, you would need to provide them.

When should I start my nondiscrimination testing?

We recommend that employers conduct their nondiscrimination testing around the fourth quarter of their plan year. At this point in the plan year, employers have the majority of the necessary data to complete the testing. Since the plan year is not over at that point, the employer often has enough time to correct any failed nondiscrimination tests without having to reissue W-2 Forms.

Some employers wait to conduct nondiscrimination testing until after their plan year is over and  have already issued their W-2 Forms. Employers who wait to complete nondiscrimination testing until after the plan year is over run the risk of highly compensated employees (and/or owners, officers, or family members as the case may be) losing the favorable tax treatment from their plan and have additional income that needs to be reported on their W-2 Forms if the plan is found to be discriminatory. Employers will then need to reissue these W-2 Forms and have difficult discussions with these key employees about their prior year’s benefits.

Should governmental entities and church plans complete nondiscrimination testing, even though they aren’t subject to ERISA?

Yes! All employers that sponsor pre-tax benefits through a cafeteria plan should test their cafeteria plan annually.

How do I get started?

Annual nondiscrimination testing is the employers’ responsibility to complete. However, Employee Benefits Corporation can perform these tests for employers.

EBC includes nondiscrimination testing services for employers with our flexible spending account (FSA), FSA Self-Administration, and Premium Only Plans (POP). Contact us for more information on our nondiscrimination testing services.