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Discrimination Testing

A Flexible Benefit Plan may not discriminate in favor of key employees or highly compensated employees (see definitions below). ProBenefits conducts discrimination testing on a regular basis to verify continuous compliance with IRS non-discrimination regulations. A simplified explanation of applicable rules follows:

Eligibility to Participate

The plan must not discriminate with respect to eligibility. Practically speaking, all full-time employees must be eligible to participate after an initial probationary waiting period. However, the plan may exclude:

  • Employees under age 21,
  • Employees with less than 1 year of service (defined as 1000 hours),
  • Certain non-resident aliens,
  • Certain employees covered by a collective bargaining agreement.

Contributions and Benefits

  • Availability - A plan must give each participant an equal opportunity to select non-taxable benefits.
  • Utilization - A plan may be deemed discriminatory if qualified benefits are disproportionately received by highly compensated participants, even if the benefits are made available to all on a non-discriminatory basis.
  • Operation - The plan must not discriminate in favor of highly compensated employees in actual operation.

Discrimination Tests

  • Benefit Concentration Test (applies to the aggregate of ALL plan benefits)
    No more than 25% of plan benefits can accrue to the group of key employees; otherwise, key employees will not receive their benefits tax-free.
  • Average Benefits Test   (applies to Dependent Care FSA only)
    The average benefit of the non-highly compensated must be at least 55% of the average benefit of the highly compensated. (For salary-reduction flex plans, those earning less than $25,000 annually may be disregarded.)

TIP: In conducting the Average Benefits Test, use the average dependent care benefit of ALL eligible employees in each group, not just those participating in the Dependent Care FSA.

The non-discrimination requirements for Flexible Benefit Plans can be complex. Please contact us if you have specific questions or concerns.

Definitions

Key Employee

Key employees - For plan years beginning on or after 1/1/15, Key Employees are those defined as any employee who, during the previous plan year, was:

  1. An officer with annual compensation greater than $170,000 (the limit is indexed periodically)
  2. A more-than-5% owner of the employer; or
  3. A more-than-1% owner of the employer with annual compensation in excess of $150,000. 

Regardless of title, an "Officer" is determined based on facts and circumstances, relating to the person's authority, term of appointment, and nature and extent of duties performed.  Officers in name only are not generally counted for purposes of this definition.   In determining officers for purposes of paragraph (1), no more than 50 employees (or, if lesser, the greater of three employees or 10% of employees) are treated as officers.

Employed spouses and children of stockholders are generally considered stockholders due to "stock attribution" rules.

Highly Compensated Employee

"Highly compensated" is a term with various meanings under the law, depending upon the specific point of reference.  In this case the definition outlined in Section 414(q) applies.  The 1996 amendments to Sec. 414(q) greatly simplified the definition of highly compensated employees.  As amended, Sec. 414(q)(1) defines a highly compensated employee as any employee who:

  1. was a 5% owner at any time during the year or the preceding year, or
  2. had compensation in excess of [indexed: $120,000 for 2015 and $115,000 for 2014] in the preceding year and, if the employer so elects, was in the "top-paid group" of employees for the preceding year. As defined by Sec. 414(q)(3), the "top-paid group" of employees for a given year is the top 20% of employees ranked on the basis of compensation received during that year.

Employed spouses of stockholders are also considered stockholders due to "stock attribution" rules.

Related items

  • Benefits Bank Account

    Employers whose plans include FSAs should establish a checking account in the bank of their choice to serve as a "benefits" bank account.

  • Key Processing Dates

    Here's a quick reference to help you keep track of our schedule.

  • Legal Compliance

    Federal law requires your company to comply with IRS regulations on proper documentation and reporting.

  • COBRA Compliance

    Learn how COBRA laws apply to your Flexible Benefits Plan.

  • New Employees

    What information is needed when a new employee is hired?