PBS Nondiscrimination Testing (NDT): FSA, POP & 105(h)


Why do we need Discrimination Testing for FSA and POP?

If you have a Flexible Spending Account (FSA) or a Premium Only Plan (POP), the IRS requires you to submit to non-discrimination testing once a year. The reason for nondiscrimination testing is to prevent key and highly compensated employees from taking advantage of the benefits that these plans provide for employers and employees alike.

What are the specific tests conducted for the FSA & POP nondiscrimination test?

There are 9 different tests, some are related to eligibility and availability of benefits and other tests are based on actual benefits elected (utilized).

  • The Section 125 Cafeteria Plan
    • Eligibility Test
    • Contributions and Benefits Test
    • Key Employee Concentration Test (utilization)
  • Health FSAs
    • Eligibility Test
    • Benefits Test
  • Dependent Care FSA (DCAP)
    • Eligibility Test
    • Contributions and Benefits Test
    • More-Than-5% Owners Concentration Test (utilization)
    • 55% Average Benefits Test (utilization)

Why conduct the 105(h) Eligibility and Benefits Nondiscrimination Testing?

Benefits under an employer sponsored health plan generally are not taxable, however, in order to ensure that employers do not improperly discriminate in favor of Highly Compensated Individuals (HCIs), Congress created nondiscrimination rules under code section 105(h). This test is designed to verify two things: First, that “enough” non-HCIs profit under the health plan. Second, to verify that the health plan’s benefits do not favor HCIs.

Types of 105(h) Testing:

There are two tests, both need to be satisfied in order to pass the 105(h) testing. The Eligibility Test and the Benefits Test.

Eligibility Test: this test focuses on whether enough the non-HCIs “benefit” under the health plan. The term “benefit” generally means the employee is actually enrolled in the plan, not just eligible to enroll.

The Eligibility Test includes:

  • 70% Test – is satisfied if the plan benefits 70% or more of all employees.
  • 70%/80% Test – the employer must first verify that 70 % or more of all employees are “eligible” to benefit under the plan. If so, the plan must actually benefit 80% or more of all those eligible employees.
  • Nondiscriminatory Classification Test – is passed if, based on certain “facts and circumstances,” the plan does not discriminate in favor of HCI eligibility.

Benefits Test: this test is generally passed if the same benefits are provided to both HCIs and non-HCIs. This test would generally be violated if an employer offered better eligibility terms for HCIs than non-HCIs. It would also be violated if benefits increase with years of service or compensation.