Nondiscrimination Testing Rules for
Health Plans
March 20, 2013
Matthew J. Flanary
Linda R. Mont
 Nondiscrimination
Health Plans – Section 105(h) Rules
Cafeteria Plans – Section 125 Rules (Briefly)
 Plans
Requiring Testing
 The Rules
 Health
And Tests
 Planning
Now For Future Changes
Nondiscrimination Testing
Applies To:
Health Plans (Section
105(h) and
Cafeteria Plans (Section 125)
The testing is different, but the goals
are the same –
Nondiscrimination Testing
Assure Plans Do Not Discriminate In Favor
Highly-Compensated Individuals (HCIs) For
Section 105(h) Plans
Highly-Compensated Participants Or
Individuals (HCEs) for Section 125 Plans
*Very Different Definitions
Definition of Highly Compensated
Section 105(h)(5)
One of the employer’s five
highest-paid “officers”
A shareholder owning more
than 10% of the employer’s
Among the top 25%
highest-paid non-excludable
Section 125(e)
A shareholder owning
more than 5% of the voting
power or value
“Highly Compensated
Spouses and Dependents
of one of the above
*Guidance referenced 414(q) rules – Compensation in excess of $115,000 (adjusted for
inflation in future years) in the preceding year and, possibly, also one of the highest paid
20% of employees
Health Plan Testing
If an employer wishes to provide a tax-free health
benefit to employees, the employer must ensure,
via nondiscrimination testing, that a self-insured
health plan does not unduly favor the highly
compensated individuals (HCIs) with respect to
either eligibility to participate or benefits.
Code Section 105(h)
Not A New Requirement
Currently Applies To Self-Insured Health Plans
Testing Is Done Annually (Regardless Of Plan
A Self-Insured Health Plan Is One In Which The District
Bears The Risk Of Paying The Claims, Including:
◦ Self-Insured Medical/Drug Plans
The Existence of Stop-Loss Insurance Doesn’t Matter
◦ Health Reimbursement Arrangements (HRA)
Code Section 105(h) Does
NOT Apply To Insured Plans
Some Insurance Requirements In Wisconsin
Without Section 105(h), Fully Insured Plans
Can (For Now) Have:
 Different Eligibility By Employee Classification
 Different Coverage By Employee Classification
 Different Medical Coverage For
 Different Lengths Of Time Or Dollar Amount Of
Retiree Medical Coverage
Code Section 105(h)
 Official Guidance Is Limited.
 More Speculation Than Regulation
 Legislation Passed In 1978
 Regulations Issued In 1981
A Handful Of IRS Rulings
 Law Repealed In 1986
 Law Retroactively Reinstated In 1989
 IRS “No Ruling” Topic
Ever Since
Health Care Reform Changes
In The Future
Expands The Current Rules To NonGrandfathered, Fully-Insured Health Plans
 But With Very Different Consequences
 Originally Scheduled
For 2011
 IRS Notice 2011-1 Delayed The Effective
Date Until After Regulations Are Published
 Later This Year?
Consequences of Noncompliance
Self-insured plans
Excess reimbursements
to HCI- Taxable
Benefits – 100% of
discriminatory benefit
Eligibility –
percentage paid to
A Two-Part Test
To Comply With Code Section 105(h),
A Plan Must Satisfy Both:
 The Eligibility
 The Benefit
Eligibility Test
A Plan Must Meet One Of The Following Tests:
70% Or More Of All “Considered” Employees Benefit Under
The Plan
70% Or More Of All “Considered” Employees Are Eligible AND
80% Or More Of All Eligible Employees Benefit Under The Plan
The Plan Benefits A Classification Of Employees Which The IRS
Finds To Be Nondiscriminatory Using Rules Similar To Those
Found In Code Section 410(b)
The 70% Short-Hand Rule
Query: Governmental Plans Are Exempt From 410(b)
Excludable Employees
105(h) 125
Employees Subject To Benefits
Non-Resident Aliens
Earnings Under $25,000
Less Than 3 Years Of Service
Less Than 1 Year Of Service
“Part-Time Employees”
“Seasonal Employees”
Under Age 25
Under Age 21
129 410(b)
Excludable employees are only excluded for 105(h) eligibility test – not benefits test and only if
not participating in any self-insured plan of the employer
Nondiscriminatory Classifications
 Reasonable:
Salaried vs. Hourly
Geographic Location
Similar Bona Fide Business
 Not Acceptable:
Naming Individuals
Criteria Having Substantially
The Same Effect
The Benefits Test
For a plan to be considered nondiscriminatory with
respect to benefits, the plan must provide the same
benefits for both highly compensated and non-highly
compensated individuals.
What’s A “Benefit”
Contributions and waiting periods are considered
benefits (See, PLR 8411050, 8411051, 8336065 and
Contributions based upon compensation are per se
discriminatory (See Treas. Reg. §1.105-11(e)(4), Example
Question about dollar amount per year of service – is
that considered a different contribution?
Example: HRA Benefit
Classification Contribution
Per Year
Administrators $2,000
Vested after 5 years
No maximum Vested at age 56 with
15 years of service
Vested after 5 years
What’s A “Plan”
An employer may designate two or more plans as
constituting a single plan that is intended to satisfy the
requirement of [Code] section 105(h)(2) and paragraph (c) of
this section, in which case all plans so designated shall be
considered as a single plan in determining whether the
requirements of such section are satisfied by each of the
separate plans. . . . A single plan document may be utilized by
an employer for two or more separate plans provided that
the employer designates the plans that are to be considered
separately and the applicable provision of each separate
- Treas. Reg. §1.105-11(c)(4)(i)
Health Reform
Did Not Change Existing Tests
New Rules Will Eventually Require Non-Grandfathered
Insured Group Health Plans To Satisfy Similar
Nondiscrimination Rules
Originally Applied To Plan Years Beginning On Or After
September 23, 2010
IRS Announced Compliance Will Not Be Required Until The
Plan Year After It Issues Regulations Or Other Guidance For
Insured Plans
Until These Rules Apply, Such Plans Are Only Subject To
Indirect Requirements Like The Cafeteria Plan Rules
Retiree Only Plans
 PPACA Exempt
Retiree-Only Plans From Many Of
The New Requirements
 It’s Possible That The Yet-To-Be Published
Insured Plan Regulations Will Also Exempt
Retiree-Only Plans.
 It’s Also Possible That Non-Federal Government
Plans Will Be Exempt
Section 125 Implication
If employees make a pretax contribution
for health insurance coverage (for a fully
insured or self-insured plan), there is
required nondiscrimination testing for
Section 125 cafeteria plans that your flex
administrator should currently be
performing on an annual basis.
Employee Contributions?
 Fully-Insured Medical Plan
Contributions on Pretax Basis:
 Administrators
pay 5% of premium
 Teachers pay 8% of premium
 Custodians pay 10% of premium
 Section 105(h) rules do not apply
 Section 125 apply
This plan would likely violate the cafeteria plan
Contributions and Benefits Test, causing the value of the
coverage to be taxable to HCIs.
What To Do Now
Review Current Plans:
Section 105(h) Plan Testing
Section 125 Plan Testing
 Consider
Potential Changes
 Add Protective Language To All Contracts And
 Consider Adding Multiple Plan Language And
Retiree-Only Plan Language
Reserve Your Rights
Consider Adding To Contracts
And Handbooks:
“The District reserves the right to make changes to coverage if
future testing rules or plan structure makes it impossible to
provide coverage.”
Consider Adding To Plan Documents:
“This Plan Document describes benefits for multiple classes of
employees and the Employer reserves the right to treat
reasonable classifications of employees and employee groups as
multiple health plans for purposes of satisfying the requirements
of Code Section 105(h), as permitted under Treasury Regulation
Section 1.105-11(d)(4)(i).”
Thank You

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