Nondiscrimination Testing

What Employers Need to Know About the Nondiscrimination Rules That Apply to Cafeteria Plans, Health Plans, and DCAP

What is Nondiscrimination Testing?

Cafeteria plans are popular because they allow employees to receive health insurance coverage from their employers without having to pay taxes on it. Intending cafeteria plans to benefit the rank-and-file employee, Congress created rules to ensure that their tax-favored status would not be used to benefit only or primarily the highest-paid or owners of a company. These rules are referred to as nondiscrimination testing. Cafeteria plans are not the only type of benefit plan that receives tax-favored status and must perform nondiscrimination testing. Self-insured plans, insured plans, Health FSAs, and DCAPs must also undergo testing. Testing for each of these will vary slightly, but although the details are different, overall concepts are similar. Nondiscrimination testing is designed to ensure that the benefits are 1) generally available to a company’s employees and are 2) being utilized by a majority of rank-and-file employees. To measure this, testing rules distinguish between rank-and-file and highly compensated employees and create threshold percentages for rank-and-file participation. Also, “nondiscrimination testing” usually means that the plan must pass two or three different tests that each address either availability of benefits or utilization of benefits.

 

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Cafeteria plans, self-insured health plans, and dependent care assistance programs (DCAPs) are subject to
nondiscrimination requirements under the Internal Revenue Code.

The requirements are generally intended to prevent these plans from discriminating in favor of certain highly paid and key employees. If a plan fails to comply with these requirements, there may be adverse tax consequences for these highly paid and key employees. For example, if a cafeteria plan is discriminatory, these employees may have to pay taxes on their cafeteria plan salary reductions.