As benefits administration
becomes more and more complicated, compliance is on everyone's to-do list. In
the compliance world of never-ending change, the following is a refresher
course for employers on a compliance requirement for Internal Revenue Code
Section 125 cafeteria plans that has not changed -- nondiscrimination testing.
What are the Nondiscrimination
The overall "25%
Concentration test" compares all the pre-tax benefits elected by
key employees with all the pre-tax benefits elected by non-key employees. Not
more than 25% of the total benefits elected by all employees may be attributed
to key employees.
Here's an example. All elections
to the cafeteria plan add up to $35,000. Of those total elections, Key employee
elections equal $5,000. Key employee elections are about 14% of the total
elections to the plan ($5,000/$35,000). In this example, the cafeteria plan
passes the 25% Concentration test.
The "55% Average Benefits
test" involves just the dependent care portion of the cafeteria plan.
The average dollar amount of benefits elected by non-highly compensated
employees must be at least 55% of the average dollar amount of benefits elected
by highly compensated employees.
In this example, let's assume
that highly compensated employees' elections are $10,000 to the dependent care
portion of the plan and there are five highly compensated employees in the
company. Non-highly compensated employees elect $19,500 to the dependent care
portion of the plan and there are 13 non-highly compensated employees. The
highly compensated average dollar amount is $2,000 ($10,000/5). The non-highly
compensated average dollar amount is $1,500 ($19,500/13). The average dollar
amount of benefits elected by non-highly compensated employees is 75% of the
average dollar amount of benefits elected by highly compensated employees
($1,500/$2,000). In this example, the dependent portion of the cafeteria plan
passes the 55% Average Benefits test.
The "25% Owner test" compares
the dependent care benefits elected by more-than-5% owners of a company with
dependent care benefits elected by non-owners. Not more than 25% of the total
dependent care benefits elected by everyone in the dependent care benefit may
be attributed to more-than-5% owners.
An example of this test would
consist of a $5,000 election to the dependent care portion of the plan by a
more-than-5% owner and elections in the amount of $19,500 made by all
non-owners. The more-than-5% owner's election is 20% of the total benefits
elected to the dependent care portion of the plan ($5,000 + $19,500 = $24,500)
($5,000/$24,500). In this example, the dependent care portion of the plan
passes the 25% Owner test because only 20% of the dependent care benefits were
elected by the more-than-5% owner.
Eligibility, benefits available
and contribution and benefits tests. These tests ensure that
employers offer all benefits to an adequate number of employees and benefits do
not discriminate in favor of highly compensated or key employees.
In the event the cafeteria plan
does not meet all the nondiscrimination requirements, employers may need to
change benefit elections and payroll amounts to bring the plan into compliance.
And, it is important to test prior to the end of the cafeteria plan year. If
testing is completed after the end of the plan year, it's too late to take
corrective action. Instead of reducing key or highly compensated elections in
order to pass the nondiscrimination test(s), the affected employees would be
taxed on their total election amount.