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What is meant by "similarly situated?" Can it apply to payroll classification?


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Employer pays 100% of the cost of single employee health coverage. It is acquiring a division with some employees who are paid by commission and would like to pay only 50% of the cost of single coverage for the commissioned employees. Employees pay their portion via a 125 plan, and all employees are eligible for the 125 plan.

§1.125-7 of the proposed regulations states that "employer contribuitions" cannot discriminate in favor of Highly Compensated Participants (HCPs), but also requires only that "similarly situated" employees be given the same benefit availability and elections. §1.125-7(e)(2) offers up geographic differences and family vs single coverage as examples of "similarly situated" employees.

HCPs represent 13% of the current population (excluding the commissioned employees). HCPs represent 12% of the commission-paid workforce (about the same as the overall population).

Could payroll classification (e.g. status as a commissioned employee) be a basis for deeming participants to be "similarly situated" such that it would be acceptable for the employer to pay a different percentage of the cost for commissioned employees as opposed to other employees, so long as the HCPs and NHCPs within each group of "similarly situated" employees receive the same employer contributions? Would there be a requirement that those deemed to be similarly situated not have vastly different HCP percentages? (Similar to the eligiblity test.)

Thanks in advance for any thoughts.

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Not answering your question directly, here's an alternate solution to consider. An employer may subsidize health coverage premiums at different levels. IRC sec 106(a) does not impose a prohibition against discriminating in favor of highly compensated employees for purposes of excluding the value of the coverage from the employee's taxable income. However, to avoid the discrimination issues of IRC sec 125, the employer must not give the employee a choice of cash or other taxable benefit instead of the payment of premiums by the employer.

For example, suppose that the cost of single coverage is $390 per month. The employer wants to pay $250 for the commissioned sales force, leaving each to pay the other $140. The employer only wants to pay $200 for the other employees, leaving each to pay the other $190. So long as an employee that doesn't want the employer to pay this part of the premiums cannot choose to receive cash or other taxable benefit in lieu of the premium payment, it is okay under IRC sec 106(a) to treat the employees differently, even if the commissioned sales force are the higher earners.

The balances of the premiums to be paid--$140 by each salesman and $190 by each other employee--could be elected and paid tax-free through the IRC sec 125 plan. To do this, however, the employer needs to be careful to establish the discrepant premium payments as a plan separate and apart from the cafeteria plan. Otherwise, you will have a highly compensated discrimination problem.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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To do this, however, the employer needs to be careful to establish the discrepant premium payments as a plan separate and apart from the cafeteria plan. Otherwise, you will have a highly compensated discrimination problem.

J-

Thanks for the reply. Indeed, here the employees would not have the right to receive cash if they did not elect to be covered by the health insurance.

To follow up on your last point, I have seen some commentary regarding establishing separate cafeteria plans for different groups of employees in order to pass nondiscrimination testing, but don't fully understand how that would work.

However, you indicated that the "plan" that would address the employer-paid premiums is separate and apart from the cafeteria plan. What plan would this be? Would this be done via the health plan? Or perhaps merely a formal employer policy that sets forth the amount paid towards health premiums? We focuse so much on 125 plans that I didn't consider 106(a).

Finally, I imagine it makes a diference whether the plan is fully insured or self-insured. This plan is fully insured but I imagine 105(h) would come into play if it was self-insured.

Thanks again.

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You are correct that any self-insured aspect of a health plan would be subject to the 105(h) discrimination. 106(a)--no prohibition against discriminating in favor of the highly paid--only applies to employer payment of premiums to a third party insurer for coverage for the employee (and spouse and dependents).

It is important where you also have a 125 cafeteria plan that the 106(a) program be very distinct and separate so that the two cannot be treated by a government entity or employee bringing suit as though just part and parcel of one "plan". While the 125 cafeteria plan might be described or its summary contained in an employee handbook, I would not include nor even mention the 106(a) plan in such an employee handbook or any other document that also describes the 125 cafeteria plan. Rather, just provide a separate SPD for the 106(a) plan to just those employees that will benefit under it. And I would not refer to the 106(a) plan as part of any "health plan" or other overarching plan. The key here is to make it and keep it separate from your 125 cafeteria plan. For example, the 106(a) plan would recite a different effective date, it would be numbered 502 if your cafeteria plan is 501.

The 106(a) would not be a cafeteria plan itself (separate cafeteria plans can exacerbate testing problems, not solve them, in many instances). The 106(a) plan would be a separate ERISA employee benefit plan, needing all those regulatory compliance 'bells and whistles' in the documents and operation.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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Hi, Don,

You would have 125 nondiscrimination issues under an employee-pay-all plan. There is an exemption in the new regs for 125 plans that are POPs if it meets the Regs 1.125-7(b)(3) safe harbor percentage test for eligibility. Regs 1.125-7(f).

You'd have to also deal with the 501©(9) discrimination rules since you have a VEBA involved.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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I have a similar issue. A client, a small employer of about 7 employees, has a cafeteria plan and only one highly compensated individual who they want to provide 100% of the health insurance premium. All other employees are offered a lesser employer contribution amount and the choice between cash or other qualified benefits. This arrangement will clearly violate the 125 nondiscrimination rules, making the benefit taxable to the highly compensated individual. Further, 2 of the 6 NHCE elect no benefits and just take the cash, which effects the benefit utilization testing. Can the employer exclude the highly compensated individual from participating in the 125 plan and provide the 100% employer contribution (non-taxable) under section 106 to the HCE. Is this a loophole? Thank you for any help you can provide.

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KLM,

Not exactly a loophole. That's how 106a was intentionally written.

The HCE would not have to be excluded entirely from the cafeteria plan for the ER to pay separately under 106a all the premiums for the HCE.

If the cafeteria plan has other benefits available, the HCE could elect and receive those to the extent the utilization test permits in light of all the benefits that the NHCEs do, including their choosing to pay health premiums through the cafeteria plan.

Keeping the payment of premiums for the HCE separate from and outside of the cafeteria plan is the key.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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