Eligibility and Benefits Non-Discrimination Testing
Benefits under an employer-sponsored health plan generally are not taxable due to a special section of the Code which excludes the value of those benefits from taxation. 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).
Currently, Code Section 105(h) only applies to self-funded health plans. A plan is generally treated as self-funded even if the plan has stop-loss insurance. In addition, the Affordable Care Act (“ACA”) provides that non-grandfathered, fully-insured health plans will also be subject to rules “similar” to Code Section 105(h).
The 105(h) Test is designed to verify two things. First, that “enough” non-HCIs “benefit” under the health plan, in comparison to the number of HCIs who “benefit.” Second, to verify that the health plan’s benefits (e.g., deductible levels and covered benefits) do not favor HCIs.
There are three typical definitions of who is an HCI. First, an “officer” of the employer will be an HCI – but only if the officer is one of the five highest-paid officers. Second, an individual who owns more than 10 percent of a corporation is generally an HCI. Finally, an individual who is among the highest-paid 25 percent of all employees (other than certain excluded employees who are not participants in the health plan), is generally an HCI.
There are two tests which both must be satisfied in order to pass the 105(h) Test.
First, the Eligibility Test focuses on whether enough non-HCIs “benefit” under the health plan. The term “benefit” generally means that the employee is actually enrolled in the plan (and not merely eligible to enroll). The Eligibility Test includes:
70 Percent Test – is satisfied if the plan benefits 70 percent or more of all employees.
70 Percent / 80 Percent Test – the employer must first verify that 70 percent or more of all employees are “eligible” to benefit under the plan. If so, the plan must actually benefit 80 percent 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.
Second, the Benefits Test is generally passed if the same benefits are provided to both HCIs and non-HCIs. The Benefits Test generally would be violated if an employer offered better eligibility terms for HCIs than non-HCIs (e.g., immediate eligibility versus 90-day waiting period). It also would be violated if benefits increase with years of service or compensation (e.g., if an HRA provided $100 in benefits for each year of employment).
Employers should periodically examine their plan structure and actual participation rates in order to verify that they pass the 105(h) Test. Failing to do so can cause HCIs to have some of their benefits become taxable. And, for fully-insured, non-grandfathered health plans, those plans could become subject to certain excise taxes if the test is failed.