Under Inter­nal Rev­enue Code Sec­tion 105(h), a self-insured med­ical reim­burse­ment plan must pass two nondis­crim­i­na­tion tests. Fail­ure to pass either test means that the favor­able tax treat­ment for high­ly com­pen­sat­ed indi­vid­u­als who par­tic­i­pate in the plan will be lost. The Sec­tion 105(h) rules only affect whether reim­burse­ment (includ­ing pay­ments to health care providers) under a self-insured plan is taxable.

When Sec­tion 105(h) was enact­ed, its nondis­crim­i­na­tion test­ing applied sole­ly to self-insured plans. Under the Patient Pro­tec­tion and Afford­able Care Act (ACA), Sec­tion 105(h) also applies to ful­ly-insured, non-grand­fa­thered plans. How­ev­er, in late 2010, the gov­ern­ment delayed enforce­ment of Sec­tion 105(h) against ful­ly-insured, non-grand­fa­thered plans until the first plan year begin­ning after reg­u­la­tions are issued. To date, no reg­u­la­tions have been issued so there is cur­rent­ly no penal­ty for noncompliance.

Prac­ti­cal­ly speak­ing, if a plan treats all employ­ees the same, then it is unlike­ly that the plan will fail Sec­tion 105(h) nondis­crim­i­na­tion testing.

What Is a Self-Insured Med­ical Reim­burse­ment Plan?

Sec­tion 105(h) applies to a “self-insured med­ical reim­burse­ment plan,” which is an employ­er plan to reim­burse employ­ees for med­ical care expens­es list­ed under Code Sec­tion 213(d) for which reim­burse­ment is not pro­vid­ed under a pol­i­cy of acci­dent or health insurance.

Com­mon self-insured med­ical reim­burse­ment plans are self-fund­ed major med­ical plans, health reim­burse­ment arrange­ments (HRAs), and med­ical expense reim­burse­ment plans (MERPs). Many employ­ers who spon­sor an insured plan may also have a self-insured plan; that self-insured plan is sub­ject to the Sec­tion 105 non-dis­crim­i­na­tion rules. For exam­ple, many employ­ers offer a ful­ly insured major med­ical plan that is inte­grat­ed with an HRA to reim­burse expens­es incurred before a par­tic­i­pant meets the plan deductible.

What If the Self-Insured Med­ical Reim­burse­ment Plan Is Offered Under a Cafe­te­ria Plan?

A self-insured med­ical reim­burse­ment plan (self-insured plan) can be offered out­side of a cafe­te­ria plan or under a cafe­te­ria plan. Sec­tion 105(h) nondis­crim­i­na­tion test­ing applies in both cases.

Regard­less of grand­fa­thered sta­tus, if the self-insured plan is offered under a cafe­te­ria plan and allows employ­ees to pay pre­mi­ums on a pre-tax basis, then the plan is still sub­ject to the Sec­tion 125 nondis­crim­i­na­tion rules. The cafe­te­ria plan rules affect whether con­tri­bu­tions are tax­able; if con­tri­bu­tions are tax­able, then the Sec­tion 105(h) rules do not apply.

What Is the Pur­pose of Nondis­crim­i­na­tion Testing?

Con­gress per­mits self-insured med­ical reim­burse­ment plans to pro­vide tax-free ben­e­fits. How­ev­er, Con­gress want­ed employ­ers to pro­vide these tax-free ben­e­fits to their reg­u­lar employ­ees, not just to their exec­u­tives. Nondis­crim­i­na­tion test­ing is designed to encour­age employ­ers to pro­vide ben­e­fits to their employ­ees in a way that does not dis­crim­i­nate in favor of employ­ees who are high­ly paid or high ranking.

If a plan fails the nondis­crim­i­na­tion test­ing, the reg­u­lar employ­ees will not lose the tax ben­e­fits of the self-insured med­ical reim­burse­ment plan and the plan will not be inval­i­dat­ed. How­ev­er, high­ly paid or high rank­ing employ­ees may be adverse­ly affect­ed if the plan fails testing.

What Are the Two Nondis­crim­i­na­tion Tests?

The two nondis­crim­i­na­tion tests are the Eli­gi­bil­i­ty Test and Ben­e­fits Test.

The Eli­gi­bil­i­ty Test answers the basic ques­tion of whether there are enough reg­u­lar employ­ees ben­e­fit­ting from the plan. Sec­tion 105(h) pro­vides three ways of pass­ing the Eli­gi­bil­i­ty Test:

  1. The 70% Test – 70 per­cent or more of all employ­ees ben­e­fit under the plan.
  2. The 70% / 80% Test – At least 70 per­cent of employ­ees are eli­gi­ble under the plan and at least 80 per­cent or more of those eli­gi­ble employ­ees par­tic­i­pate in the plan.
  3. The Nondis­crim­i­na­to­ry Clas­si­fi­ca­tion Test – Employ­ees qual­i­fy for the plan under a clas­si­fi­ca­tion set up by the employ­er that is found by the IRS not to be dis­crim­i­na­to­ry in favor of high­ly com­pen­sat­ed individuals.

The Ben­e­fits Test answers the basic ques­tion of whether all par­tic­i­pants are eli­gi­ble for the same benefits.

For infor­ma­tion on who is a high­ly com­pen­sat­ed indi­vid­ual, how the tests are applied, when to test, and what to do if you fail the test (includ­ing excess reim­burse­ment exam­ples), request UBA’s Com­pli­ance Advi­sor, “Sec­tion 105(h) Nondis­crim­i­na­tion Test­ing”.

Orig­i­nal­ly pub­lished by www.ubabenefits.com