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Section 105 Nondiscrimination Tests


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Hypo: For 2009, a self-insured medical plan fails (i.e., will fail) the 70% eligibility test and the 70%/80% eligibility tests under the Code Section 105(h) nondiscrimination tests. The plan fails the nondiscriminatory classification eligibility test if only participants in the plan are counted (the conservative approach) and passes the test if all eligible employees are counted (the favorable approach).

I understand that there is some uncertainty as to which employees should be included in the test and guidance from the IRS would be helpful but are there any thoughts as to what should the plan do now?

If the plan chooses to rely on the more favorable approach and does nothing, what will be the consequence in the unlikely event that the IRS discovers this in a plan audit and takes the position that the more conservative approach is the correct one?

If the plan is "fixed" in 2009, the HCIs will pay taxes on their pro-rata portion of the excess reimbursements. Presumably, that will also be the effect if the issue arises in an audit. Are there additional penalties for failing to correct a discriminatory plan?

The plan passes the subjective benefits test.

Any thoughts would be extremely helpful.

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Guest Sieve

If the plan does not pass nondiscrimination eligibility testing (IRC Section 105(h)(3), then the result is that any excess reimbursements to an HCE will not be excluded from the HCE's gross income. (IRC Section 105(h)(1).) In the case of eligibility testing, an excess reimbursement is, basically, the total amount reimbursed to that employee for the year, multiplied by a fraction--the numerator of the fraction is the total amount reimbursed to all HCEs, and the denominator of the fraction is the total amount reimbursed to all employees. (IRC Section 105(h)(7) and Treas. Reg. Section 105-11(e)(3).)

Note that an HCE for MERP purposes is different--and much broader--than the pension HCE definition. (IRC Section 105(h)(5).)

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If the plan does not pass nondiscrimination eligibility testing (IRC Section 105(h)(3), then the result is that any excess reimbursements to an HCE will not be excluded from the HCE's gross income. (IRC Section 105(h)(1).) In the case of eligibility testing, an excess reimbursement is, basically, the total amount reimbursed to that employee for the year, multiplied by a fraction--the numerator of the fraction is the total amount reimbursed to all HCEs, and the denominator of the fraction is the total amount reimbursed to all employees. (IRC Section 105(h)(7) and Treas. Reg. Section 105-11(e)(3).)

Note that an HCE for MERP purposes is different--and much broader--than the pension HCE definition. (IRC Section 105(h)(5).)

Thanks for the response Sieve. My question has to do with the consequences of the IRS finding out about the failure AFTER 2009 (say in 2010 or 2011). What will the IRS make the HCEs/plan do then?

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Guest Sieve

Failure to correct a discriminatory MERP simply continues to result in tax consequences for HCEs. The plan is not required to be non-discriminatory (as long as you pay the price). Sort of like a qualified plan--if you don't correct, then you have tax consequences--except that a MERP can continue to operate while discriminatory.

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  • 3 weeks later...
IRS will require the employer to amend the W-2 forms, the HCEs to amend their personal tax returns, and will then collect taxes, penalties and interest.

Thanks. Do you know or can you point me to a resource that can tell me what the "penalties" are that are separate and apart from the underpaid taxes and interest?

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I would think the accuracy related penalty, IRC sec 6662(a).

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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