What is Nondiscrimination Testing?

If your company offers any form of a pre-tax welfare benefits plan such as group Medical, Dental, Vision or Life insurance (commonly referred to as a Premium Only Plan or POP), or a Flexible Spending Account (commonly referred to as an FSA or Cafeteria Plan), there is an IRS requirement to test your benefit plan for Nondiscrimination Testing on an annual basis. These tests are designed to make sure that the company is treating all of its employees relatively in regards to their benefits package and not giving employees who are highly compensated or in management positions and better benefits than their lower-paid or non-management employees.

Who Needs to Test and When?


While it is easy to overlook, nondiscrimination testing is an essential piece of a company’s compliance requirements. If an employer does not perform this annual testing or does not adequately follow the steps necessary for this testing, it could lead to some hefty consequences, including losing their ability to offer pre-tax welfare benefits to their employees. 

HR Service, Inc. helps relieve that stress by performing this annual test in a timely and affordable manner.

No matter what type of benefits your company offers, HR Service, Inc. can ensure that your company is following the IRS testing requirements.

How Many Nondiscrimination Tests are There?

Depending on what type of benefits your company offers, there are up to nine different tests that may need to be administered. Some tests are related to eligibility and availability of benefits, and some are based on how many employees have elected these benefits. We have included a list of tests that are required for each of the most common benefit packages companies offer: 

  • The Key Employee 25% Concentration Test applies to all pretax benefits provided under the plan. No more than 25% of the aggregate of all non-taxable benefits may be provided to key employees. This would include anything paid pretax (by an employee) or provided on a nontaxable basis (by the employer), including Group health, term life, or disability coverage premiums Health and Dependent Care FSA Contributions to an HSA. The Dependent Care 55% Average Benefits Test applies only to the Dependent Care FSA.
  • The 105(h) Nondiscrimination Testing is passed if the average benefit provided to employees who are non-HCEs is at least 55% of the average benefit provided to HCEs. 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, 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. Also, 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:

    1. First, that “enough” non-HCIs “benefit” under the health plan, in comparison to the number of HCIs who “benefit.” 
    2. Second, to verify that the health plan’s benefits (e.g., deductible levels and covered benefits) do not favor HCIs.
  • The 5% of Owners Test also applies only to Dependent Care FSA. Not more than 25% of the amounts for dependent care assistance during the year may be provided for shareholders or owners (or their spouses or dependents) who own more than 5% of the stock, the capital, or profits interest in the employer (on any day of the year

FAQ - Nondiscrimination Testing

What are the Employee Contributions?

Section 105(h) rules suggest that employee contributions for HCIs and non-HCIs must be the same. These rules provide that a health plan that provides optional (elective) benefits to participants will satisfy the benefits test if: All participants are eligible to elect the optional benefits, and there are either no required employee contributions or the required employee contributions are the same amount.

As a permissible design option, a self-insured health plan may establish a maximum reimbursement limit for any single benefit or combination of benefits. However, any maximum limit attributable to employer contributions must be uniform for all participants (and for all dependents of employees who are participants) and may not be modified by reason of a participant's age or years of service. If a plan covers HCIs and the type or the number of benefits subject to reimbursement under the plan are in proportion to employee compensation, the plan will fail the benefits test.



The IRS has suggested that having a longer waiting period for non-HCIs than HCIs will cause a self-insured health plan to fail the benefits test.


Failure to provide testing results during an IRS audit of the plan may result in plan disqualification which could lead to tax penalties for the employer and participants.

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