A cafeteria plan can pass every test in January and fail by December. Testing belongs inside the plan year.
Nondiscrimination tests look at who actually elected and who actually received benefits, and those numbers move all year. We track testing and substantiation while the plan runs, so a routine FSA or HRA does not become an audit risk or a surprise tax bill for your executives.
Several tests, each asking a different question about who benefits.
The tests compare highly compensated and key employees with everyone else. Each can fail for a different reason, which is why we run them separately instead of as a single checkbox.
Eligibility
Who is allowed to participate. A plan that excludes groups where rank-and-file employees cluster, such as part-time staff, can fail before anyone elects. We review eligibility first because it is the easiest thing to fix before the year starts. Eligibility review is the first step in cafeteria plan nondiscrimination testing.
Contributions and Benefits
Who actually elects, and how much. A plan can be open to everyone and still fail if executives use it heavily and others do not, which is why participation matters as much as design. Participation drives the contributions and benefits test.
Key Employee Concentration
Benefits going to key employees cannot exceed a set share of the plan’s total. In a small company where owners contribute heavily, this is the test that tends to bite, so we watch it from the first payroll. Key employee concentration testing matters most for owner-heavy small businesses with a cafeteria plan.
Dependent Care Average Benefits
Average dependent care benefits for non-highly compensated employees must be at least 55 percent of the average for highly compensated employees. Few employees use dependent care, so a handful of large elections can fail it. Dependent care FSA testing deserves early attention.
Failing a test does not end the plan. It changes who pays tax.
When a cafeteria plan fails, the usual consequence is that the affected highly compensated or key employees lose the tax exclusion while rank-and-file employees keep theirs. That is why the fix is aimed at the right people, early.
Testing Early
We run a preliminary test after enrollment, when elections are known and there is still time to act. A problem found in the first quarter can be corrected; one found after year end can only be reported. Early testing turns a failure into a fixable warning.
Mid-Year Corrections
Where the plan allows, elections of highly compensated employees can be reduced going forward so the plan passes. We identify the adjustment and the people it affects, and your counsel confirms the approach before anyone is told. Timely corrections help a cafeteria plan pass.
Year-End Documentation
We keep the final results with the plan records. If the plan is ever examined, the question is not only whether it passed but whether you can show that it did. Documented test results protect a cafeteria plan in any IRS examination, and they cost little to keep.
Every reimbursement needs proof. Card swipes are not an exception.
IRS rules treat unsubstantiated reimbursements as a problem for the plan, not only for one claim. We monitor substantiation continuously rather than at year end.
Open Card Transactions
Swipes that could not be verified at the point of sale stay open until a receipt arrives. We track them and send reminders, so open transactions do not pile up into a year-end problem. Consistent follow-up keeps FSA and HRA substantiation compliant.
Correcting Improper Payments
When a swipe turns out to be ineligible, the plan follows a set sequence: suspend the card, seek repayment, offset against later claims and, as a last resort, treat the amount as wages. We follow it in order, because skipping steps is what puts the plan at risk.
Document and Platform Match
The platform should enforce exactly what the plan document says. We compare the two every year, because a setting that has drifted from the document is an operational failure even when each claim looks reasonable. Annual comparison keeps plan operations compliant.
What employers ask about FSA and HRA compliance.
Do small employers have to test?
Yes. The tests apply regardless of size, and small employers fail them more easily, because a few owners can outweigh everyone else in the plan. Small employers should test early each plan year, before a few large elections decide the result.
Who counts as highly compensated?
It turns on ownership and prior-year pay above an IRS threshold, with a separate definition for key employees. We apply the definitions to your payroll data each year and flag edge cases for your CPA. Accurate classification is the foundation of FSA and cafeteria plan nondiscrimination testing.
Is there a safe harbor for small employers?
A simple cafeteria plan can be treated as meeting certain tests if eligible small employers meet its contribution and eligibility requirements. Whether it suits you is a cost question we can model. A simple cafeteria plan can help eligible small employers pass FSA testing.
Where the Rules Come From.
The laws and rules named on this page link to the statute or regulation they come from. This is general information, not legal or tax advice, and rules change, so check the current text.
Cafeteria Plans (26 U.S.C. 125)
The tax code section that lets employees pay certain benefit premiums before tax.
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