FSAs and Nondiscrimination Testing Failure

[Guest jw13]

Our TPA is asking for data to perform nondiscrimination testing for our medical expense and dependent care FSA plans under sections 105 and 129. I have spent a few days trying to wrap my mind around the IRC and accompanying regulations, including reading a lot of posts here. Our plans are open to all employees on equal terms and are 100% funded from voluntary employee elections. I would appreciate any guidance on the following.

1. Medical Expense Eligibility-It seems that mere eligibility to participate in the FSA is not enough to count toward the 70% threshhold. So, if significantly more of our top 25% decide it is worth the paperwork and use-or-lose risk, even though the program is all voluntary employee elections, can the plan flunk?

2. Excess HCI Reimbursement-If HCIs participate too much and the plan flunks, I assume we would need to make corrections by year end to tax the appropriate disparate share for HCIs. Are plan documents required to notify employee of this risk?

Thank you again for any clarification.

[Guest John14]

Depending on the entity (i.e., if LLC or S corp), I think the only test that really matters is the benefits test for the DCA plan. IIRC, for LLCs and S corps, you can't fail the other tests if everyone is eligible.

[Guest jw13]

Depending on the entity (i.e., if LLC or S corp), I think the only test that really matters is the benefits test for the DCA plan. IIRC, for LLCs and S corps, you can't fail the other tests if everyone is eligible.

I am looking at a governmental plan, and common sense makes me want to reach the result that a plan that lets everyone participate is nondiscriminatory, but I am not seeing how Section 105(h) lets that happen.

As I read 105(h)(3)(A), a plan cannot be nondiscriminatory unless it benefits 70% or more of all employees or "80 percent or more of all the employees who are eligible to benefit under the plan if 70 percent or more of all employees are eligible to benefit under the plan." Using both "benefits" and "eligible to benefit" suggests that eligibility alone does not get you there. Is there someplace else that I am missing or a letter ruling that makes clear that plans that let everyone participate really are nondiscriminatory. Perhaps I am just being paranoid, but then I wonder why our TPA needs data to crunch the numbers for medical expenses FSAs if it knows that everyone is eligible.

Thanks for any clarification anyone can provide.