Nondiscrimination testing for varying contributions

[Morgan]

I have a situation around Nondiscrimination Rules for a Fully-Insured group with a section 125 plan. They have different employer contributions for Salary & Hourly employees in the same geographic location under the same EIN. The employer is Large Group so they have a 4 tiered composite rate structure and the contributions for the Salary & Hourly employees are below:

 

Employer Contributions

Hourly - EE 75%, ES 75%. EC 75%, FAM 75%

Salary - EE 100%, ES 75%. EC 75%, FAM 75%

 

The Hourly group doesn't have any HCPs and the Salary group has many HCPs so at first I thought this would be discriminatory since the contribution scheme favors the group with HCPs. My question is, Since the salary employees in the EE-Only tier are getting 100% of their benefits paid for would they be excluded as participants in the section 125 plan? If that group of EE-Only salaried employees is removed from testing then the remaining employees are all provided uniform employer contributions. Would this pass nondiscrimination testing?

 

One concern I have is that a salary employee can be in the EE-Only Medical tier, but then have a Child they are covering on Dental in the EC tier and that pre-tax dental deduction would loop them back into the section 125 testing. 

 

Any guidance or thoughts would be greatly appreciated. 

 

[Brian Gilmore]

I would still consider that to be a contribution structure that doesn't comply with the uniform election rule component of the Section 125 nondiscrimination rules.  The EE-only tier isn't providing a uniform election with respect to employer contributions for the non-HCPs, and therefore it's discriminatory in favor of HCPs in that tier.  I'm assuming it's the same underlying medical plan option(s) at issue for both groups.

13 hours ago, Morgan said:

My question is, Since the salary employees in the EE-Only tier are getting 100% of their benefits paid for would they be excluded as participants in the section 125 plan?

Your argument that the salaried employees with the 100% ER contribution effectively aren't part of the cafeteria plan at that EE-only tier because they have no contribution is a creative one (kudos), but my feeling is the IRS would consider it too clever by half.  

13 hours ago, Morgan said:

One concern I have is that a salary employee can be in the EE-Only Medical tier, but then have a Child they are covering on Dental in the EC tier and that pre-tax dental deduction would loop them back into the section 125 testing. 

That would be my position here. 

No real way to answer this definitively since guidance is limited (and enforcement experience is essentially nil), but for what it's worth I would advise the client to change that structure.

The workaround I'd suggest is that there is never any issue with providing a greater taxable salary/wage to employees.  If the salaried EEs were paid a greater amount intended to cover the increased cost of coverage, the salaried EEs could then make an election to apply that extra amount on a pre-tax basis to the employee-share of the premium.  That would put both parties in largely the same position as if they had received the larger employer contribution.

I put out a couple of posts diving into this topic that might be interesting/helpful:

• https://www.newfront.com/blog/designing-health-plans-with-different-strategies
• https://www.newfront.com/blog/nondiscrimination-rules-for-different-health-plan-contribution-structures-2

 

Here's the relevant cites:

Prop. Treas. Reg. §1.125-7(c)(2):

(2) Benefit availability and benefit election. A cafeteria plan does not discriminate with respect to contributions and benefits if either qualified benefits and total benefits, or employer contributions allocable to statutory nontaxable benefits and employer contributions allocable to total benefits, do not discriminate in favor of highly compensated participants. A cafeteria plan must satisfy this paragraph (c) with respect to both benefit availability and benefit utilization. Thus, a plan must give each similarly situated participant a uniform opportunity to elect qualified benefits, and the actual election of qualified benefits through the plan must not be disproportionate by highly compensated participants (while other participants elect permitted taxable benefits)…A plan must also give each similarly situated participant a uniform election with respect to employer contributions, and the actual election with respect to employer contributions for qualified benefits through the plan must not be disproportionate by highly compensated participants (while other participants elect to receive employer contributions as permitted taxable benefits).

Prop. Treas. Reg. §1.125-7(e)(2):

(2) Similarly situated. In determining which participants are similarly situated, reasonable differences in plan benefits may be taken into account (for example, variations in plan benefits offered to employees working in different geographical locations or to employees with family coverage versus employee-only coverage).

[Morgan]

Thanks Brian! I really appreciate your insight.

I felt like I was getting too creative as well with my argument about the Salaried EE-only employees being excluded from testing.

 

[Brian Gilmore]

Yeah I get squeamish about that argument even where the class has no contribution at any tier.  I feel like unless the class is ineligible to participate in the cafeteria plan by the Section 125 rules (e.g., more than 2% shareholders, LLC members, partners in a partnership) there's going to be risk there.

[Luke Bailey]

10 hours ago, Morgan said:

I felt like I was getting too creative as well with my argument about the Salaried EE-only employees being excluded from testing.

This argument actually has some technical merit, I think, since salaried employees for whom self-only coverage is the best fit really have no choice between cash and benefits, I'm assuming. That's especially the case for salaried employees who have neither spouse nor dependents. The reason it doesn't look like a strong argument is that the salaried self-only coverage is probably in the cafeteria plan document as a choice, even if only indirectly through a reference to the company's medical plan. I would certainly make the argument for any past years, though, in the event of an exam. Whether it's worth trying to structure salaried employee only coverage as a separate benefit outside the cafeteria plan (plan documents and election forms) is an involved question, but probably doable. Just specifically exclude salaried self-only from the cafeteria plan's reference to the medical plan and leave it out of the cafeteria plan election process. Communicate to the salaried employees that if they are going to take self-only coverage, they do not need to make a health plan election under the cafeteria plan because the coverage is automatic.

All of the above assumes that salaried employees who don't want coverage at all are not permitted to receive cash for that election. In other words, I'm assuming that the default, if the salaried employee made no election, is self-only coverage.

[Chaz]

What would the consequences be to the highly compensated participants in the event that the IRS determined that this plan design was "too creative"?

[Brian Gilmore]

Loss of the Section 125 cafeteria plan safe harbor from constructive receipt for the HCPs--

Prop Treas. Reg. §1.125-7(m):

(m) Tax treatment of benefits in a cafeteria plan.

(1) Nondiscriminatory cafeteria plan. A participant in a nondiscriminatory cafeteria plan (including a highly compensated participant or key employee) who elects qualified benefits is not treated as having received taxable benefits offered through the plan, and thus the qualified benefits elected by the employee are not includible in the employee’s gross income merely because of the availability of taxable benefits. But see paragraph (j) in §1.125-1 on nondiscrimination rules for sections 79(d), 105(h), 129(d), and 137(c)(2), and limitations on exclusion.

(2) Discriminatory cafeteria plan. A highly compensated participant or key employee participating in a discriminatory cafeteria plan must include in gross income (in the participant’s taxable year within which ends the plan year with respect to which an election was or could have been made) the value of the taxable benefit with the greatest value that the employee could have elected to receive, even if the employee elects to receive only the nontaxable.

[Chaz]

For HCEs for whom the employer pays 100% of the cost of coverage, wouldn't that be $0 in extra gross income?

[Brian Gilmore]

Well it would affect all HCPs.  Not all of them are in the fully employer-paid tier of EE-only coverage.

[Chaz]

Okay that makes sense but what if the plan design is to pay 100% of the cost of coverage for HCPs and 75% for non-HCPs regardless of the tier of coverage?  What would the tax consequences be to those HCPs in that scenario?

[Brian Gilmore]

I agree in that situation there's nothing to point to in the rules that could show any adverse tax consequence to the HCPs because they are not put in a constructive receipt position by the arrangement.  I still think it could potentially invite further scrutiny on the plan as a whole, though.  With limited guidance here (and almost no enforcement activity) there are many judgment calls to make.

[Luke Bailey]

But again, you'd want to separate the HCP portion of the medical plan from the cafeteria plan in terms of both documentation and communications.

[Jennifer Hagen]

Since this world of non-discrimination testing is so gray, I have a good one for you.  

I work for a large physician group.  The majority of our workforce are HCEs.  We have one health plan with no class distinctions.  All physicians and employees are eligible for the same plan with the same eligibility rules.  Here is the ER contribution structure:  EE-100%, EE+SP-$400, EE+CH-$250, FAM-$550.  Now this is only for the Employees.  For physicians we pay 100% of all plans including dependents.  Is this plan considered discriminatory?  We have passed 125 testing as we are not required to report the premiums paid if the ER pays 100%.  Now if the physician works less than FT hours, we do charge them for that portion of the ERs cost of their benefits so in a way we are not treating them the same.

In my past life we recommended another physician group to gross up salaries for the physicians so that we show that we are treating everyone the same.  What is your recommendation?  We have never done 105(h) testing and not sure if we need to do so.

Appreciate it!

Jennifer Hagen

[Brian Gilmore]

Are the physicians ineligible for the Section 125 cafeteria plan?  If so, that structure would make sense.  If not, that seems unlikely to fly under the uniform election rule cited above.