Informal Poll-IRS Enforcement of Nondiscrimination Rules

[Guest gaham]

As anyone who has worked with these plans knows, there are a number of nondiscrimination rules that are applicable to 125 plans as well as to the underlying plans (health FSAs, dependent care plans, etc.). Most, if not all, of these rules are plagued with inconsistencies, ambiguities and very little meaningful guidance. Except in certain small employer situations, where the discrimination violation is obvious, I don't believe there is much worry about compliance. And, frankly, I am not sure there is much need to worry because I, personally, have seen no enforcement action whatsoever from the IRS in this regard. This leads me to my question: Has anyone had any experience with the IRS making any effort to enforce any of these rules? If so, please share what you can about your experience. Thanks.

[papogi]

I have been in the "Section 125 world" for many years, and have never seen the IRS audit the Section 125 plan of any of my company's clients. In mid-2000, the IRS issued a draft of 125 audit procedures to its agents, a first. This raised the concern that the IRS may finally be ready to begin auditing 125 plans. The IRS has since been trying to improve its image, as we all know, so the frequency of audits has gone down. That is likely to change over the next couple years, however. In any event, you are correct that in a practical sense, you can probably conduct your 125 plan any way you want without much worry of an audit. As members of a democracy regulated by rules and laws passed down by officials elected by ourselves, we have a responsibility to adhere to the rules regardless of the likelihood or unlikelihood of being caught. The rules are not arbitrary hurdles set up by the IRS to make our jobs harder. They are based on a goal of fairness, and their complexity is understandable given the many influences the rulemakers have to try to balance. I'm not trying to preach here, believe me, but the rules still exist even without an audit. While their rules are sometimes ambiguous (the lack of audits has caused a lack of court guidance), you can usually come to a comfortable interpretation when you look at each case individually, and use resources such as this message board for other interpretations.

[SLuskin]

I have never had a client's cafeteria plan audited as the primary reason for an audit. I have had 3 clients (in a 12 year period) whose plans were audited because of improprieties in the 401K and some I9 or other problem which alerted the auditors. I have had any number of clients with 401K audits, and the auditors did not look at the cafeteria plan. Certainly if it is a flex plan, daycare in particular, which does show up on the W-2, why risk not testing. We test our plans and send the clients letters to show that they have passed, or not. If not, the remedies are in the letters as well. Our clients are glad that we do the testing, as well as provide guidance on change of status issues, etc.

[Guest akwallace]

I have a question related to this topic, and I am hoping that one of you can help me with it.

Do the Section 125 Plan rules actually require that an employer perform the discrimination testing?

I just joined a company, and they did not perform the actually testing for this year, based on the assumption that "some quick calculations indicated that we would have no trouble passing".

Looking for guidance on whether we have to perform the actual testing, or just be in compliance if ever audited.

Thanks.

[Guest gaham]

There is no testing mandate. Theoretically, you simply must be able to show that the plan satisfies the applicable nondiscrimination rules. So if you can show that your plan will pass without full blown testing, that will suffice.

[Joe Priselac]

As far as I know there is no requirement to perform actual calculations and have a permanent record of the test results. In some situations it is obvious that certain non discrimination requirements are being met without actually performing the calculations of a discrimination test. For example, an employer whose plan prohibits key employees from participation would not be required to perform the calculations of the key employee concentration test to determine that the plan was in compliance.

In other situations it is less obvious if a plan is in compliance and therefore the tests should be performed.

[J2D2]

Just wanted to revive this post to see if anyone has seen any more IRS activity on the Section 125 non-discrimination testing issue.

[Chaz]

Any updates on IRS enforcement of these nondiscrimination requirements?

[Jacmo]

I've been doing this for 20 years and never had a client audited for a 125 plan. However, I had an associate who worked the eastern part of the state that I'm in, that had a number of clients audited for their 125 plan.

Those audits occurred as a by product of, or in conjunction with, a routine payroll audit.

In my whole career, I was only indirectly connected with a 125 audit, which for the agent involved, was a total nightmare and consumed 1 to 2 days a week of the agents time and dragged on for 5 months. But I've heard of nothing in recent years.

We occassionally see or hear of random DOL audits which have far more serious financial implications, as a rule. And the DOL is not as easy to "negotiate" with as the IRS.

[Guest mjb]

The IRS only audits FSAs as a payroll matter because there are no final regs on the 125 non discrimination provisions (proposed regs are uninforceable and need to be revised for changes in law).

I dont know what the dol would audit in an FSA.

[Don Levit]

Are there non discrimination rules for a section 125 plan, if there is only a fully insured health insurance policy in the arrangement?

Don Levit

[Jacmo]

Sorry--I didn't mean to imply that the DOL was auditing FSAs. I meant that these were the only types of audits we are seeing (Health and Welfare benefits--ERISA issues).

I am correcting myself--FSAs are ERISA plans!