Discrimination testing of an FSA plan is required on an annual basis to assure the plan has been implemented to the benefit of all employees and not just a select few. To meet the qualifications for tax-favored status, an FSA plan cannot discriminate in favor of Key or Highly Compensated employees.
Before reviewing the discrimination testing requirements let’s learn more about these two types of employees:
Key employees include:
- An officer receiving annual pay greater than $170,000*; or
- An employee with either
- Greater than 5% ownership in the business; or
- Greater than 1% ownership in the business with annual pay of more than $150,000*.
Highly compensated employees include:
- Officers of the company;
- An owner of at least 5% of the company for the applicable plan year being tested or in the 12 months preceding the tests;
- Any employee with gross annual compensation before deduction of more than $120,000* during the 12 months prior to the testing year;
- The spouse and dependent children of an employee meeting the highly compensated definition are considered to meet the definition of highly compensated as well.
*Salary amounts given are for years 2015 (subject to index adjustment for future plan years).
FSA discrimination testing includes review of Eligibility along with Contribution and Benefit which demonstrates compliance as follows:
Eligibility to participate in an FSA plan must not discriminate in favor of highly compensated employees. Meeting the eligibility testing requirement generally includes the following:
- 70% or greater of all non-excludable employees must benefit (regardless of their status as a highly compensated or non-highly compensated employee);
- 80% or more of these employees who are eligible to benefit; and
- Employees qualifying under a classification that does not discriminate in favor of highly compensated employees.
Contribution and Benefit Test
The test for contribution and benefit (which is also known as the Utilization Test) determines the plan is not discriminating to the benefit of highly compensated employees thereby assuring all eligible plan participants have the same opportunity to elect the non-taxable benefit. All participants and their dependents must have the same treatment in regard to required employee contributions, maximum benefits and waiting periods.
The following tests are required to demonstrate compliance in this regard:
- Key Employee Concentration Test must show key employees are not receiving greater than 25% of the non-taxable benefits in total.
- Dependent Care Spending Account Test must show the average benefits received by non-highly compensated employees are at least 55% of the average benefit received by highly compensated employees. Also, testing must show shareholders and owners of at least 5% of the company are not receiving more than 25% of the total dependent care benefit.
IRS Reporting Requirements
Form 5500 must be filed for all FSA plans no later than 7 months after the end of the plan year. Compliance and testing results are subject to audit by the IRS.
In closing, as with all Employee Benefit plan discrimination testing, it is imperative that proper oversight be conducted by the plan administrator to assure continued regulatory compliance. Such oversight includes appropriate review prior to commencement of the benefit plan year as well as periodic review during the year to assure continued compliance by events such as employees entering or leaving the plan or by employee election changes due to a qualifying event.
The contribution limitation which went into effect on January 1, 2015 of $2,550 on Health FSAs and $5,000 on Dependent Care FSAs will reduce the likelihood of non-compliance, but appropriate oversight is still vital.