Section 105(h) and employee contribution limits

[Guest erinf]

A client wants to set different maximum contribution limits for employee contributions to a health FSA under section 125 based on length of service. The TPA has said that doing so would violate nondiscrimination under 105(h) based on Treas. Reg. 1.105-11©(3)(i), which says that any maximum contribution limits on employer contributions cannot be modified based on length of service, etc.

I'm fine with applying this to employer contributions, but these are employee contributions. The TPA takes the position that once the employee contributes to the section 125 plan, the money becomes an employer contribution. I disagree, but have nothing more solid to go on then my logic, which doesn't always line up with the IRS logic. The further problem is that I see this done on a semi-frequent basis and have never thought it would fail nondiscrimination. Has anyone seen anything to contradict (or support) what the TPA is saying?

[QDROphile]

The TPA is correct about effect, but not correct in the description -- at least the description you gave. Under section 125 the employee has a choice between benefits and cash. If the employee chooses benefits, the employee foregoes the cash compensation. The employee does not get the cash compensation and then contribute it. No employee contributions are transformed into employer contributions. The employer provides the benefit with employer funds.

ERISA looks at the arrangements differently, but you are dealing with tax code provision in your question, not ERISA.

By the way, the same deal applies to 401(k) plans. Elective deferral amounts are employer contributions, not employee contributions.

[Guest erinf]

The TPA is correct about effect, but not correct in the description

If I understand you correctly, because the employee picks to have the benefit instead of the cash, establishing a different maximum employee contribution based on length of service is actually the employer deciding to contribute a larger benefit to some based on length of service, which would violate 105(h)?

[QDROphile]

The employer is providing benefits. Now go look at the regulation. It says the "all the benefits provided for participants who are highly compensated individuals are provided for all other participants" and "any maximum limit ... must be uniform for all participants ... and may not be modified by reason of a participant's age or years of service."