Compliance

A plan can pass every other compliance check and still turn an executive’s benefit into taxable income.

Cafeteria plans and self-funded medical plans must not favor highly compensated or key employees. When a test fails, the plan keeps running but the favored group can lose the tax advantage, often without anyone noticing until year-end. We run the tests early enough to change the result.

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What Gets Tested

Different plans, different tests, one consequence.

Each arrangement has its own tests and its own definition of who counts as favored. We match the test to the plan before we run anything.

Cafeteria Plans

Section 125 looks at who is eligible, who actually benefits and how much of the total pre-tax benefit goes to key employees. A fairly designed plan can still fail on participation, because rank-and-file employees choose not to use it. Test early to catch it.

Health FSAs

Health flexible spending accounts are tested on eligibility and benefits. An employer contribution only some employees can reach, or a design that favors salaried staff, is where a health FSA tends to slip, so we look at the design first.

Dependent Care Accounts

Dependent care assistance has its own tests, including one that compares the average benefit of non-highly compensated employees with that of highly compensated employees. The result turns on who uses the account, which the employer does not control. Dependent care FSA testing can fail even with a well-designed plan.

Self-Funded Medical

Section 105(h) applies to self-insured medical reimbursement plans, including level-funded plans and HRAs. When eligibility or benefits favor highly compensated individuals, their excess reimbursements can become taxable, which is why executive-only medical arrangements need a close look. Section 105(h) testing belongs on the annual compliance calendar for every self-funded plan.

How FSA and HRA testing is monitored through the year →

The Rule That Bites

Testing once at year-end only tells you what already went wrong.

The data that decides a test is the data at the end of the plan year, when there is little room to fix anything. So we test at the start of the year, again mid-year and a final time before the year closes.

Test Early

An early test uses projected elections, so its result is a warning rather than a verdict. It gives you time to adjust the design, or the elections of the favored group, while the plan year is still open. Early non-discrimination testing is simply cheaper.

Correct Going Forward

A common correction is reducing the pre-tax elections of highly compensated or key employees for the rest of the year. We check that the plan document permits it before anyone promises it, because an unauthorized fix creates a new problem.

Keep the Record

A passing test that is not on file is hard to prove in an audit. We keep each test, its data and its date with the plan records, and your CPA confirms the tax treatment wherever a test fails. Records protect the plan.

The other audit most employers skip →

What the Test Needs

Most failed tests start as a data problem, not a design problem.

The tests depend on who is highly compensated, who is a key employee and who owns what. Get those wrong and a passing result means nothing.

Compensation Data

Prior-year compensation drives who counts as highly compensated. We take it from payroll records, not memory, because a single misclassified executive can change the outcome for a small group. Accurate payroll data is the foundation of every cafeteria plan and Section 105(h) test.

Ownership and Family

Ownership can be attributed between family members, so an owner’s spouse or child can count as a key employee without holding shares. We ask directly, since payroll systems do not track it. Attribution rules can change the key employee count in a small company overnight.

Related Companies

Employers under common ownership may have to be tested together. When a controlled group question is open, we bring in the CPAs and attorneys available through us, since that determination is theirs to make. Controlled group status affects every non-discrimination test that follows.

How executive benefits are structured instead →

Common Questions

What employers ask about testing.

Do fully insured employers need to test?

Yes, if they have a cafeteria plan. The Section 125 tests apply to pre-tax premiums and FSAs whether the medical plan is insured or self-funded; the self-funded medical test is the one that turns on funding. Fully insured employers with a Section 125 plan still need annual testing.

What happens if we fail?

The plan keeps operating and rank-and-file employees keep their tax treatment. The favored group’s benefit can become taxable, and your CPA decides how that is reported, which is why we involve them early. Failing a non-discrimination test is fixable, especially when it is caught early.

We are a small company. Does this really matter?

It matters more. A few owners and managers make up a larger share of a small group, so their elections move the result. That is the reason to test, not a reason to skip it. Small employers gain the most from testing early in the plan year.

How testing fits your compliance program →

Sources

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.

Affordable Care Act (Public Law 111-148)

The 2010 health reform law, with later amendments, behind employer coverage, reporting and market rules.

Read the Text

Cafeteria Plans (26 U.S.C. 125)

The tax code section that lets employees pay certain benefit premiums before tax.

Read the Text

Let’s Get to Work

Send us your renewal.

We’ll tell you whether it looks competitive, where we see opportunity, and the five questions we’d put to your carrier. No cost, and no obligation to move anything.

What to send

The renewal letter
Your current plan summary
Contribution split by tier
Enrolled counts by tier

Four documents — two more if your group is 50 or more. Nothing else; every extra one is a reason to postpone.

CFH Insurance Consultants

An independent employee benefits consulting firm. We look at the entire benefits program — cost, plan performance, risk and administration.

Switch to CFH. Unhappy with your broker? Your employees won’t notice. You will. →

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