There are several Internal Revenue Codes that apply depending on the plan type. Importantly, these rules apply differently based on your group funding, not your group size. The point of the NDT is to ensure the plans do not favor highly compensated individuals (HCI – Section 125, 129, and 105 (h) apply) or key employees (Section 125 and 79 apply) over non-HCIs and non-key employees.
Are you offering a group health plan with employee contributions that are taken with pre-tax deductions? If so, you must have a Section 125 Cafeteria Plan (100+ employees) or a Simple Cafeteria Plan, also known as a Premium Only Plan (POP <100 employees). The Cafeteria Plan or POP document should be tested to see if the plan favors HCI’s, key Employees, or non-employees. Non-employees consist of more than 2% shareholders of an S-Corp, partners of an LLPs, members of LLCs, and their spouses/dependents, and these individuals are not eligible to participate in the Cafeteria/POP plan. The main eligibility test will look at the waiting period and class structure to see if the HCIs are favored. The employer contributions and benefits are tested to ensure they are available – fairly – to all employees. Section 125 includes medical, dental, vision, FSA, DFSA, HSA, Life Insurance, disability, and adoption assistance.
Is your group health plan self-funded? In this case, there are additional rules for HCI’s that apply under this tax code Section 105 (h). This also includes Health Flexible Spending Accounts. The main eligibility test will look at HCIs vs non-HCIs contributions, benefit levels that do not vary based on age, years of service, or compensation, waiting periods, and group health plans.
Do you offer a Dependent Care Flexible Spending Account? In that case, tax code Section 129 then applies.
How about group term life and supplemental health plans? Then Section 79 applies.
Going Deeper
At any time of year, the recommendation for testing is annually but as of the last day of the plan year. However, testing sooner allows time to correct the plan if it fails before the close of the tax year. Some clients will have an initial test, and then subsequent years if no changes are made, forgo the annual NDT (this is not recommended, however).
The allowable classes are full-time vs part-time, current vs former, geographic, occupation, date of hire, and length of service. There are also employees who can be excluded from the testing if they are excluded from the Cafeteria Plan or group health plan. You can also elect to exclude your HCI’s and key employees from the cafeteria plan, they will simply not pay for benefits on a pre-tax basis.
You may be wondering what happens if the plan has never had the testing before, is there a penalty? The simple answer is no, there is no penalty for not performing the NDT. The penalty comes into play if your plan gets audited and you cannot produce the current NDT results. The tax implications would generally fall to the key employees and HCIs to pay taxes on the benefits they received, meaning they could not be pre-taxed, and the value would then become part of their gross income for the period evaluated. If the tax year has closed out, penalties can be assessed on the employer for failure to handle the taxation correctly. The non- HCI’s are generally left unaffected by this.
If all eligible employees are treated the same, the risk of failing the NDT is low. If you would like to have your plan tested, please reach out to your client manager for access to one of our partners.
