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105(h) nondiscrimination


Guest cc1898
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Employer has a total of 3 employees- 2 NHCE and 1 HCE. Currently, the 2 NHCE are eligible to receive benefits and do receive benefits. The HCE is not yet eligible, but will be soon. The HCE will not be taking benefits. Accordingly, the health plan would not meet the 70% rule under 105 (h) b/c 2 out of 3 is 66%.

I think this is a non-issue since the nondiscrimination rules are directed towards the tax treatment HCEs receive for health benefits. Here, the HCE is not taking the benefits and therefore there shouldn't be any unfavorable tax treatment for the HCE. The fact that the health plan wouldn't pass the 70% rule won't affect the NHCE's tax treatment.

If I'm missing anything, could someone please comment?

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Guest Mr. Kite

I assume this is a self-funded, rather than an insured plan.

The definition of HCE/NHCE is not used in 105(h) -- rather, it is a "Highly Compensated Individual," which casts a broader net. In fact, one or both of the NHCEs could, in fact, be an HCI. If that is the case, and if the nonparticipation by the HCE causes the plan to be considered discriminatory, the participating NHCE/HCI(s) will have to treat the "excess reimbursement" as income. If each of the 2 participants receives $5,000 in benefits, and one of them is an HCI, the excess reimbursement is $2,500 ($5,000 x $5,000/$10,000). If both participants are HCIs, the excess reimbursement for each is $5,000 ($5,000 x $10,000/$10,000).

There is an argument that you can exclude from the discrimination testing any employee that is an "excludable employee," even though the employee is, in fact, eligible. However, this doesn't help here, because even if one or both of the 2 participants are excludable (for example, part-time), you still won't meet the 70% or the 80%/70% tests.

There are some who argue that an employee "benefits" from a plan if the employee is eligible, but it is not a strong argument. This is discussed in the EBIA Cafeteria Plan manual at page 1789-1790.

It seems like the plan would pass the "classification" test in 105(h)(3)(A)(ii), except for the fact that the test is based on who "benefits" rather than who is "eligible" (which seems rather odd, because the employer does not "classify" those employees who choose to participate/benefit). The EBIA manual discusses this beginning at page 1792.

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