Correcting Discrimination Due to Disparate Waiting Periods

[401 Chaos]

Suppose you have a self-insured health plan that improperly provided certain new employees (including highly comped) with the ability to participate and receive benefits in the plan immediately while other employees (nearly all non-highly) were required to wait 60 days to participate. Based on prior guidance, this appears a clear 105(h) violation. There is some IRS guidance (JCEB Q&A, other comments) noting that one possible way around these issues would be for the highly compensated employees receiving the extra / early coverage to pay for that or have that amount imputed in their income. That was not done in real time. Would it be possible for the employer to go back and impute the value (presumably full COBRA cost) of the early coverage in the highly compensated participant's income now and head off any possible future challenge by IRS of a 105(h) violation which could lead to taxation of the benefits received by the participants (and not just imputing cost of coverage). So, basic question is can you retroactively impute income to "fix" the 105(h) issue for open tax years or has a 105(h) violation already occurred since the amount was not imputed in real time?

[Bill Presson]

I don't have an answer, but remember that it's very rare for a new employee to qualify as an HCE.

[BG5150]

But isn't there something about employees whom you reasonably expect to be an HCE when looking at people who are included early?

If not, then why not let your brand-new CFO right into the plan; he's (currently) an NHCE after all...

[401 Chaos]

Thanks. It does seem relying on a potential technical exemption there would basically swallow the rule in nearly all cases--i.e., you are mostly only going to have a waiting period applicable to new hires.

[Bill Presson]

I'm not saying anyone should be let in early. I think the rules should be applied equally. But we're sometimes faced with different tasks: tell me what to do correctly from here on v. how do we fix something that happened in the past.

Like I said in my first post: I don't have an answer. But sometimes a "technically correct answer" is helpful so I just wanted to post the reminder.

[401 Chaos]

Bill,

Many thanks. I understand your point. Just to be sure we're on the same page though, as I understand the definition of "Highly Compensated Individuals" for 105(h) purposes, especially the top 25% of employees based on compensation category, the rules are not all that clear but do not seem to suggest a look back year and I think arguably could be read to apply generally at any point in time during the plan year such that a newly hired / entering employee that was clearly within the top 25% of pay at entry may need to be counted as an HCI right away. Does that make sense or are you thinking of another way to possibly exclude from the HCI category. Similarly, inclusion of top 5 officers (rather than top 25%) seems even clearer that may should be assessed / applied immediately upon entry.

I have not found any direct discussion of the specific imputation issue but the EBIA manuals and other sources seem to generally suggest that the nondiscrimination tests cannot be satisfied by correction made after the plan year has ended in encouraging frequent testing and possible adjustments throughout the year. I suppose they may typically be thinking of other types of corrections / adjustments to benefits than going back and imputing income to HCIs, i'm concerned that those sorts of "corrections" might be prohibited as well. Code Section 105(h)(1) indicates that a self-insured plan must satisfy the tests for "the plan year" suggesting that the plan should pass the tests at all times during the plan year. I think that is how they get to the general thought that corrections after the plan year are not possible. I think that could probably rule out any effort to retroactively impute amounts into income as a fix. Although I suppose if the employer were willing to make an employee whole on that and/or the amounts were relatively small it might be worth trying as a fix anyway.

[rocknrolls2]

I would like to make one thing very clear regarding the prior posts: 105(h) does NOT use a 414(q) definition of HCE (unless the IRS guidance on insured health plans does so and provides guidance with respect to self-insured plans as well). Instead, discrimination in favor of highly compensated individuals is prohibited. A highly compensated individual is defined as one of the five highest paid owners, a shareholder who owns more than 10% of the employer's stock; or is included among the highest paid 25% of all employees (other than employees who can be excluded for purposes of the test, such as employees with less than 3 years of service, employees who have not attained age 25, part-time or seasonal employees or collectively bargained employees). This determination, from the Code's actual language does not appear to support a look-back determination. Therefore, do not assume that you will not be a highly compensated individual merely because you are newly hired. I have also seen authority that if the amounts are paid with after-tax amounts that they will not be taken into account for purposes of 105(h) nondiscrimination testing.

[401 Chaos]

Rocknrolls,

Thanks for your post. I am with you on the HCI test under 105.

Regarding your last sentence, I read that to suggest that if the company had arranged to have the coverage paid for by the HCIs with after-tax amounts (rather than say imputing the value of that coverage into the HCIs' income) that we think there is an argument for avoiding the 105(h) discrimination issue. I'm assuming, however, that you are not necessarily saying you've seen support where having the HCIs pay for the amounts on an after-tax basis several years after the close of a particular plan year helps solve the problem (i.e., I think we are in agreement that there may be a way to avoid creating these issues going forward but not necessarily a way to fix prior violations)?

[Bill Presson]

I would like to make one thing very clear regarding the prior posts: 105(h) does NOT use a 414(q) definition of HCE (unless the IRS guidance on insured health plans does so and provides guidance with respect to self-insured plans as well). Instead, discrimination in favor of highly compensated individuals is prohibited. A highly compensated individual is defined as one of the five highest paid owners, a shareholder who owns more than 10% of the employer's stock; or is included among the highest paid 25% of all employees (other than employees who can be excluded for purposes of the test, such as employees with less than 3 years of service, employees who have not attained age 25, part-time or seasonal employees or collectively bargained employees). This determination, from the Code's actual language does not appear to support a look-back determination. Therefore, do not assume that you will not be a highly compensated individual merely because you are newly hired. I have also seen authority that if the amounts are paid with after-tax amounts that they will not be taken into account for purposes of 105(h) nondiscrimination testing.

Thanks. I wasn't intending to confuse the issue.