Nondiscrimination Testing Rules for Health Plans

WASBO Accounting SeminarMarch 20, 2013

March 21, 2012

Speakers: Matthew J. Flanary Linda R. Mont

AgendaNondiscrimination Testing

Health Plans – Section 105(h) Rules Cafeteria Plans – Section 125 Rules (Briefly)

Plans Requiring TestingThe Rules And TestsHealth ReformPlanning Now For Future Changes

Nondiscrimination Testing

Currently Applies To:Self-Funded Health Plans (Section

105(h) and Cafeteria Plans (Section 125)

The testing is different, but the goals are the same –

Nondiscrimination Testing

Assure Plans Do Not Discriminate In Favor Of:Highly-Compensated Individuals (HCIs) For Section 105(h) PlansHighly-Compensated Participants Or Individuals (HCEs) for Section 125 Plans

*Very Different Definitions

Definition of Highly CompensatedSection 105(h)(5)One of the employer’s five highest-paid “officers”A shareholder owning more than 10% of the employer’s stockAmong the top 25% highest-paid non-excludable employees

Section 125(e)“Officers”A shareholder owning more than 5% of the voting power or value“Highly Compensated Employees”*Spouses and Dependents of one of the above

*Guidance referenced 414(q) rules – Compensation in excess of $115,000 (adjusted for inflation in future years) in the preceding year and, possibly, also one of the highest paid 20% of employees

Health Plan TestingIf an employer wishes to provide a tax-free health benefit to employees, the employer must ensure, via nondiscrimination testing, that a self-insured health plan does not unduly favor the highly compensated individuals (HCIs) with respect to either eligibility to participate or benefits.

Code Section 105(h) Not A New Requirement Currently Applies To Self-Insured Health Plans Testing Is Done Annually (Regardless Of Plan

Size)

A Self-Insured Health Plan Is One In Which The District Bears The Risk Of Paying The Claims, Including:

◦ Self-Insured Medical/Drug Plans The Existence of Stop-Loss Insurance Doesn’t Matter

◦ Health Reimbursement Arrangements (HRA)

Code Section 105(h) Does NOT Apply To Insured Plans

Some Insurance Requirements In Wisconsin Without Section 105(h), Fully Insured Plans

Can (For Now) Have: Different Eligibility By Employee Classification Different Coverage By Employee Classification Different Medical Coverage For Different

Retirees Different Lengths Of Time Or Dollar Amount Of

Retiree Medical Coverage

Code Section 105(h)Currently

Official Guidance Is Limited. More Speculation Than Regulation

History Legislation Passed In 1978 Regulations Issued In 1981

A Handful Of IRS Rulings Law Repealed In 1986 Law Retroactively Reinstated In 1989 IRS “No Ruling” Topic Ever Since

Health Care Reform Changes

In The FuturePPACA Expands The Current Rules To Non-

Grandfathered, Fully-Insured Health Plans But With Very Different Consequences

Originally Scheduled For 2011 IRS Notice 2011-1 Delayed The Effective

Date Until After Regulations Are Published Later This Year?

Consequences of Noncompliance

Self-insured plansExcess reimbursements

to HCI- TaxableBenefits – 100% of

discriminatory benefit Eligibility –

percentage paid to HCI

A Two-Part Test

To Comply With Code Section 105(h), A Plan Must Satisfy Both:

The Eligibility Test

The Benefit Test

Eligibility TestA Plan Must Meet One Of The Following Tests: 70% Or More Of All “Considered” Employees Benefit Under The

Plan

70% Or More Of All “Considered” Employees Are Eligible AND 80% Or More Of All Eligible Employees Benefit Under The Plan

The Plan Benefits A Classification Of Employees Which The IRS Finds To Be Nondiscriminatory Using Rules Similar To Those Found In Code Section 410(b)

The 70% Short-Hand Rule Query: Governmental Plans Are Exempt From 410(b)

Excludable Employees 105(h) 125 129 410(b)Employees Subject To Benefits Bargaining x x x xNon-Resident Aliens x Earnings Under $25,000 x Less Than 3 Years Of Service x Less Than 1 Year Of Service x x“Part-Time Employees” x “Seasonal Employees” x Under Age 25 x Under Age 21 x xExcludable employees are only excluded for 105(h) eligibility test – not benefits test and only if not participating in any self-insured plan of the employer

Nondiscriminatory Classifications

Reasonable: Salaried vs. Hourly Geographic Location Similar Bona Fide Business

Criteria

Not Acceptable: Naming Individuals Criteria Having Substantially

The Same Effect

The Benefits Test

For a plan to be considered nondiscriminatory with respect to benefits, the plan must provide the same benefits for both highly compensated and non-highly compensated individuals.

What’s A “Benefit”

Contributions and waiting periods are considered benefits (See, PLR 8411050, 8411051, 8336065 and 8423036)

Contributions based upon compensation are per se discriminatory (See Treas. Reg. §1.105-11(e)(4), Example 6)

Question about dollar amount per year of service – is that considered a different contribution?

Example: HRA Benefit

Classification

Contribution Per Year

Maximum Contributio

n

Eligibility/Vesting

Administrators

$2,000 $60,000 Vested after 5 years

Teachers $2,500 No maximum Vested at age 56 with 15 years of service

Non-Represented Staff

$1,000 $30,000 Vested after 5 years

What’s A “Plan”

An employer may designate two or more plans as constituting a single plan that is intended to satisfy the requirement of [Code] section 105(h)(2) and paragraph (c) of this section, in which case all plans so designated shall be considered as a single plan in determining whether the requirements of such section are satisfied by each of the separate plans. . . . A single plan document may be utilized by an employer for two or more separate plans provided that the employer designates the plans that are to be considered separately and the applicable provision of each separate plan. - Treas. Reg. §1.105-11(c)(4)(i)

Health Reform Did Not Change Existing Tests New Rules Will Eventually Require Non-Grandfathered

Insured Group Health Plans To Satisfy Similar Nondiscrimination Rules

Originally Applied To Plan Years Beginning On Or After September 23, 2010

IRS Announced Compliance Will Not Be Required Until The Plan Year After It Issues Regulations Or Other Guidance For Insured Plans

Until These Rules Apply, Such Plans Are Only Subject To Indirect Requirements Like The Cafeteria Plan Rules

Retiree Only PlansPPACA Exempt Retiree-Only Plans From Many Of

The New Requirements It’s Possible That The Yet-To-Be Published

Insured Plan Regulations Will Also Exempt Retiree-Only Plans.

It’s Also Possible That Non-Federal Government Plans Will Be Exempt

Section 125 Implication

If employees make a pretax contribution for health insurance coverage (for a fully insured or self-insured plan), there is required nondiscrimination testing for Section 125 cafeteria plans that your flex administrator should currently be performing on an annual basis.

Employee Contributions? Fully-Insured Medical Plan

Contributions on Pretax Basis: Administrators pay 5% of premium Teachers pay 8% of premium Custodians pay 10% of premium

Section 105(h) rules do not apply Section 125 apply

This plan would likely violate the cafeteria plan Contributions and Benefits Test, causing the value of the coverage to be taxable to HCIs.

What To Do Now

Review Current Plans:Section 105(h) Plan TestingSection 125 Plan Testing

Consider Potential ChangesAdd Protective Language To All Contracts And

HandbooksConsider Adding Multiple Plan Language And

Retiree-Only Plan Language

Reserve Your Rights

Consider Adding To Contracts And Handbooks:

“The District reserves the right to make changes to coverage if future testing rules or plan structure makes it impossible to provide coverage.”

Consider Adding To Plan Documents:“This Plan Document describes benefits for multiple classes of employees and the Employer reserves the right to treat reasonable classifications of employees and employee groups as multiple health plans for purposes of satisfying the requirements of Code Section 105(h), as permitted under Treasury Regulation Section 1.105-11(d)(4)(i).”

Thank You