As published in The Self-Insurer,
It should be no surprise that self-insured health plans, cafeteria plans, and dependent care assistance programs (DCAPs) are subject to non-discrimination requirements under the Internal Revenue Code. This has been the case for some time. More recently, PPACA established non-discrimination requirements, as set forth in the Public Health Service Act (PHSA) section 2716, for fully insured health plans and this renewed focus on non-discrimination has creating a testing frenzy in the marketplace.
The non-discrimination requirements are premised on the fact that if an employer (may require controlled group analysis) wishes to provide tax-free benefits to its employees, the employer must ensure that in doing so it does not unduly favor those employees that would be deemed highly compensated and/or key personnel, and if a plan fails to comply with these requirements there may be adverse tax consequences for these employees.
With regard to fully insured plans, section 1001 of PPACA added section 2716 to the PHSA which prohibits fully insured non-grandfathered group health plans from discriminating in favor of highly compensated individuals in accordance with the principles set forth in Code section 105(h) that were previously only applicable to self-insured health plan. However, the IRS has postponed enforcement until further guidance can be provided, and at this time, there is little to no indication that the guidance is forthcoming any time soon.
Nonetheless, for self-insured health plans, cafeteria plans and DCAPs it is status quo – testing is required and discrimination is prohibited. Although these plans (as well as HRAs and FSAs) are all subject to non-discrimination testing, the tests are not identical and some of the applicable definitions differ. For instance, section 105(h) prohibits discrimination in favor of Highly-Compensated Individuals (HCIs) and section 125 prohibits discrimination in favor of Highly-Compensated Participants and Individual (HCEs) and Key Employees.
For section 105(h) testing purposes, an HCI is an individual who is:
- one of the employer’s five highest paid officers;
- a shareholder owning more than 10% in value of the stock of the employer; or
- among the highest paid 25% of all non-excludable employees.
Section 105(h) allows the exclusion of the following individuals from the highest paid 25%:
- employees who have not attained the age of 25;
- employees who have not completed three years of service;
- part-time or seasonal employees;
- non-resident aliens; and
- collectively bargained employees.
HCEs For section 125 testing purposes, HCEs on the other hand include the following:
- employees owning more than 5% of the voting power or value of all classes of stock of the employer during the current or preceding plan year;
- highly compensated; or
- a spouse or dependent of an individual set forth above.
Section 125, under certain circumstances, allows the potential exclusion of the following individuals from the eligibility and participation requirement:
- employees who have not attained the age of 21;
- employees who have not completed one year of service;
- non-resident aliens; or
- collectively bargained employees.
For section 125 testing purposes, a Key Employee is any employee who, during the plan year, was:
- an officer of the employer with an annual compensation in excess of a specified dollar threshold;
- more than a 5% owner of the employer; or
- more than a 1% owner of the employer with an annual compensation in excess of a specified dollar threshold.
For years, many employers have merely paused to assess whether their plan(s) satisfies the non-discrimination requirements. However, the non-discrimination requirements are complex and require a more thorough analysis to make this determination.
The general components of the self-insured health plans, cafeteria plans and DCAP testing requirements can be narrowed down to eligibility, benefits, availability and utilization.
Self-Insured Health Plans
Eligibility and benefits are considered in the analysis of a self-insured health plan. The plan must satisfy one of the following
three tests in order to satisfy the eligibility component:
- 70% or more of all non-excludable employees benefit under the plan;
- 80% or more of all eligible employees, if 70% or more of all non-excludable employees are eligible to participate under the plan; or
- the plan benefits a classification of employees which the IRS finds to be non-discriminatory.
Likewise, the plan must satisfy the benefits test by providing similar benefits to the HCIs and non-HCIs. The maximum benefit level cannot be based on compensation, age, or years of service, and the type of benefits must be identical for all participants without differing waiting periods.
Eligibility, benefits, availability and utilization are considered in the analysis of a cafeteria plan. The plan must satisfy all three of the following eligibility requirements:
- it must benefit a non-discriminatory classification of employees;
- the employment requirement must be the same for all employees with no more than three years of employment needed for all employees to be eligible to participate; and
- eligibility cannot be later than the first day of the plan year after the employment requirement is met.
With regard to availability and utilization in a cafeteria plan, the requirements will be satisfied if: ‘reasonable’ classifications do not discriminate in favor of HCIs; ‘similarly situated’ employees are treated the same; non-taxable benefits are not disproportionately elected by HCIs; HCIs are not favored in the actual operation of the plan; and qualified benefits provided to key employees do not exceed 25% of the total of all such benefits provided for all employees under the plan.
Dependent Care Assistance Programs (DCAPs)
Eligibility, benefits and utilization are considered in the analysis of a DCAP plan.
Again, ensuring that the benefits offered benefit employees who qualify under a classification that does not discriminate in favor of HCEs. The ‘reasonableness’ test for the cafeteria plan is utilized, however, here an HCE is defined as an employee who owns more than 5% during the current or preceding year or the employees compensation during the preceding year exceeded $115,000 for 2012, 2013, and 2014.
Benefits cannot favor HCEs and no more than 25% of the amount paid for DCAP benefits during the year can be provided to individuals (including spouses and dependents) that have more than 5% ownership.
With regard to utilization, the average DCAP benefits provided to non-HCEs must be at least 55% of the average benefits provided to HCEs. Many times, non-HCEs don’t understand the value in electing DCAP benefits and plans often end up with more HCEs utilizing the benefits which may cause the plan to fail. Some employees may be excluded from the test as set forth above, however, it is important to run the test so the employer knows for sure whether the plan passes the test.
A common question is always “when should I test?” If a plan has never tested before they should test now! Ideally, a plan should test mid-year and at the end of the plan year. However, plans that have not been testing should perform a test now for the 2013 plan. If the test(s) fails then they will likely have some modifications to make now for 2014. If the test(s) passes and there were not many changes made for 2014, they may be safe waiting until the end of the current plan year. If changes were made then a mid-year test would be prudent and recommended. Some circumstances that could significantly impact results, employers have little control over. Something as simple as a disproportionate number of HCIs electing coverage or more importantly, and more likely, a disproportionate number of non-HCIs not electing coverage may cause a plan to fail and unlike 401(k) testing, employers are not afforded the opportunity to do cleanup from a failed test after the end of the plan year.
If you have not already done so, this would be a good opportunity to educate your clients, provide a service offering, and/or encourage your clients to seek legal/compliance assistance. I would encourage you to also review your Administrative Service Agreements and see how it addresses the testing requirements. For plans that have not had testing on their radar, now would be a good time to start, and depending upon the results, they may need to review their plan documents and consider potential plan modifications.
The reality is, we don’t have a lot of guidance on section 105(h) testing and for most folks, the regulations themselves might as well be written in Latin. However, with the focus now on the fully insured plans as a result of PPACA, there is no doubt that there is going to be a renewed spotlight on the self-insured plans.
This article is intended for general informational purposes only. It is not intended as professional counsel and should not be used as such. This article is a high-level overview of the non-discrimination requirements applicable to certain health plans. Please seek appropriate legal and/or professional counsel to obtain specific advice with respect to the subject matter contained herein.
This article is intended for general informational purposes only. It is not intended as professional counsel and should not be used as such. This article is a high-level overview of regulations applicable to certain health plans. Please seek appropriate legal and/or professional counsel to obtain specific advice with respect to the subject matter contained herein.