105(h) Nondiscrimination Tests

[Chaz]

Must a church-sponsored health FSA satisfy the Code Section 105(h) nondiscrimination tests?

[vebaguru]

If a church adopts a qualified plan, it must live by (albeit somewhat relaxed) qualified plan rules. But the church doesn't need the tax deduction. The reason for adopting a qualified plan is to be able to provide vested (protected) benefits without the amounts becoming taxable to the employees.

Similarly, if a church adopts a flex plan, it must live by flex plan rules. In this case, however, the reason for complying with the 125 rules is so that the employee salary deferrals are, in fact, tax deductible. As a nonprofit, the church could find other ways of paying such benefits that would not be taxable, just as above the church could provide nonqualified benefits rather than qualified benefits. However, given that the church wants the employees to fund the accounts from their paychecks, compliance is not optional.

[Chaz]

This makes sense but the 105(h) nondiscrimination tests I am referring to are not the Section 125 tests but are the ones that are generally required for health FSAs because health FSAs are self-insured medical plans. Does this change your answer?

[vebaguru]

In your post, you described these amounts as FSAs, which are governed by Section 125, not 105. Had you asked about HRA amounts set aside for payment of benefits, then 105(h) would have been the applicable Code section and the answer would have been different. But so would the facts.

The issue with contributions coming from the employer is whether or not they are tax deductible to the employer, and the 105(h) test applies. However, this employer does not need tax-deductibility.

The issue with contributions coming from the employees is whether or not they reduct the employees' taxable income and the 125 test is required.

[Chaz]

It is my understanding (and has been for quite awhile) that health FSAs are self-insured medical reimbursement plans and are subject to both the nondiscrimination tests under Code Section 105 and those under Code Section 125.

In fact, see Proposed Treas. Reg. 1.125.5(l), which states, in the first line, "Section 105(h) applies to health FSAs."

[Chaz]

Does anyone have any thoughts?

[vebaguru]

You seem to be asking:

"We have a flex plan under Section 125. In addition to the nondiscrimination requirements under IRC section 125, do we also have to test the arrangement for compliance with section 105)h)?"

If that is your question, you have now answered it yourself.

[Chaz]

If the plan is a church plan, yes.