Does Nondiscrimination Testing Apply to your Company?

By Brett Hunter, Compliance Analyst

We’re approaching the end of the 2019 Calendar year, which means that for many plan sponsors, it’s time to perform Nondiscrimination Testing. Do you know if you should be performing these tests? Let’s look at some information that plan sponsors should be aware of.

How do I know if I need to test for Nondiscrimination?

Any employer or plan sponsor who provides employees with a Cafeteria Plan (defined in IRC §125) are required by the IRS to perform Nondiscrimination testing. This ensures that pre-tax benefits are not disproportionately available to or utilized by Highly Compensated Individuals (HCI) relative to Non-Highly Compensated Individuals. Failure to perform testing or failure of the tests themselves can result in the HCI losing their favorable pre-tax benefits in the event of an IRS Audit. This means that both the HCI and the company will have to reclassify income in their tax returns and potentially be subject to interest and penalties.  However, there are some ways to prevent this administrative nightmare.

When should I test my plans?

The IRS requires testing to be performed by the last day of the plan year for the Cafeteria Plan. However, simply performing testing at the end of the year can leave employers and plan sponsors exposed to penalties, as corrections are not allowed to be made retroactively after the year’s end. To prevent failures, perform mid-year testing to allow adequate time to make corrections. These corrections can help prevent employers from being subject to large penalties by the IRS and having incredibly frustrated employees having to refile their taxes.

What are the changes to Nondiscrimination Testing in 2019?

Typically, compensation thresholds have changed annually for determining the prohibited group members in a plan. The compensation threshold for being classified as a key employee has increased from $175,000 to $180,000 for officers. For Highly Compensated Employees, the threshold has increased from $120,000 to $125,000. Other characteristics for defining key employees and HCE’s remain the same (see IRC §125) and it is likely these thresholds will increase for 2020 as well. These changes in compensation thresholds can affect the Nondiscrimination testing results, so it is important to be aware of them to ensure you are testing accurately.