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Section 125 plan OK where all employees are HCEs?


Guest Laurie Dalton

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Guest Laurie Dalton

We have only HCE's who want to have a cafeteria plan where no Key employees are going to partcipate. Can we have a Health Insurance Premium and Dependent Care contribution 125 plan? Do we have problems with non-discimination testing?

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papogi:

[i interpret the question as saying the employer only employs highly compensated employees.]

How would you flunk the nondiscrimination test if the employer has no non-highly compensated employees?

Are you saying that the IRS would demand that the employer go out and hire some non-highly compensated employees in order to satisfy the non-discrimination test?

Kirk Maldonado

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The problem comes when you apply the mathematical formulas of 1.410(B)-4, which I know some people don’t feel should be used. Since the IRS includes an NHCE percentage down to zero, the safe harbor percentage read from the chart would still apply, in my view. If the IRS felt that a company with no NHCE’s would automatically pass the test, then a 0% concentration would not have been included on the chart. While NHCE’s aren’t really being discriminated against when there aren’t any NHCE’s in the first place, part of the definition of an HCE is a 5% owner of a company, and the IRS does not cafeteria plans comprised of only 5% owners. Perhaps I’m way off base, but that’s what the math says.

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As an example, a company consisting of 10 people, each of whom is at least a 5% owner in the company, cannot have a working 125 plan even if all of them participate. They are all key employees, and 125 plans are designed to be for the benefit of employees. To the IRS, a company such as the one I described does not have true employees.

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  • 2 weeks later...

Who made that rule....?? I have run into this before as well where all 3 e/ee's of a medical practice are HCE's. In the qualified plan (401(a)) area, it's OK to have a plan that benefits only HCE's. What's the policy difference here?

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I know that the 25% test is specific to 125 plans. I was only raising the tax policy issue as to why an e/er with only HCE's as e/ee's can have a profit sharing plan, but cannot maintain a cafeteria plan. In the profit sharing plan context, no non-highly's employed means no discrimination issue. I was just questioning why there is not a similar outcaome with respect to 125 plans. Again, I understand your analysis re the 25% concentration test...

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  • 2 weeks later...

I e-mailed the IRS and asked whether an employer who employed only HCE's could have a cafeteria plan. The following is the response I received:

" NOTE: Our response to your tax law question appears below. If you have a follow-up question or another general tax law question, please return to our web site at: (http://www.irs.gov/help/page/0,,id=13162,00.html) to submit it. Please do not use your "reply" button to respond to this message. More helpful information is provided at the end of this message.

For privacy and security purposes, your incoming e-mail text has been deleted in this response because it either asked a tax account question, which we do not answer (we answer tax law issues only), or it contained personal identification information.

The Answer To Your Question Is:

Please accept our apology for the delay in answering your e-mail inquiry.

You can not have a Cafeteria Plan if there are no non-highly compensated employees. You will not pass the nondiscrimination test.

Please refer to Introduction to Cafeteria Plans at http://www.valuedesign.com/HRforms/IRSIntr...ria%20Plans.pdf and Publication 15-B, Employer s Tax Guide to Fringe Benefits, at the IRS web site listed below.

You can view the Internal Revenue Code (Title) 26, Section 125, at the U. S. House of Representatives web site at http://uscode.house.gov/usc.htm and you can view the Code of Federal Regulations 26, Sections 1.125-1 and 1.125-2, at the U. S. National Archives and Records Administration web site at http://www.access.gpo.gov/nara/cfr/cfr-tab...ble-search.html

IRS forms and publications may be accessed on our web site at the following address: http://www.irs.gov/formspubs/index.html or ordered through our toll-free forms lines at:

800-829-1040 IRS Tax Help Line for Individuals

(NEW) 800-829-4933 Business and Specialty Tax Help Line

(NEW) 800-829-1954 Refund Hotline

which are available 24 hours a day, 7 days a week, with 7-10 days delivery time.

We are interested in your opinion and providing the best possible service to you. Please take a moment to answer our survey at: http://www.irs.gov/help/page/0,,id=13155,00.html

This answer is based on our understanding of the facts you presented in your question. Omission of facts may affect the answer given.

Here's a tip for navigating the IRS web site. Use the "search" button at the bottom of the home page. Enter key words or phrases for your topic in the entry box. It could help you find your answer immediately.

EMPLOYEE ID: 04-06189 Mr. Hayes Tel.:(800)829-1040 msg#: 1282128 "

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Just as a side note, remember that under the FSA there is no maximum cap on the amount that can be reimbursed under the FSA. If the only participants were owners, I believe, in the IRS's eyes, there is the potential for abuse and more sheltering of income whereas if there are non-owner employees the employer is then forced to look at liability and other issues.

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