This is a message to Plan Sponsors of Cafeteria Plans, including Premium Only Plans (POP) and Plans with Health Care and/or Dependent Care Spending Accounts and/or Employer Flex Credits.

Many Plan Sponsors do not realize that Cafeteria Plans, even Premium-Only Plans, are required by the IRS to perform Non-discrimination Testing every year to ensure that a group's Cafeteria Plan does not favor Highly Compensated Employees (HCEs) or Key Employees (owners/officers).

Specifically, there are three basic components to the testing:

• The Eligibility Test determines whether the plan is broadly offered to non-HCEs along with HCEs.
• The Contributions and Benefits Test determines not only whether plan benefits are available to non-HCEs on the same or similar terms as HCEs, but may also reveal whether HCEs are in practice receiving more of the benefit than non-HCEs. 
• As its name implies, the Key Employee Concentration Test has to do with Key Employees rather than HCEs. This test determines whether such Key Employees receive more than 25% of the total benefits under the plan.

For smaller groups (especially those with five employees or less), the ratio of HCEs participating in the pre-tax plan versus Non-HCEs is often higher. In addition, Key Employees are oftencompensated more and therefore tend to purchase more benefits than do non-Key Employees (e.g. family medical coverage versus employee-only medical coverage). Either of these scenarios, in practice, may more easily result in the failure of non- discrimination testing for smaller groups.

What happens if the plan fails?

If a plan fails non-discrimination testing, all is not lost: the plan is not disqualified. However, HCEs and Key Employees can lose their tax-favored status. Specifically, HCEs and Keys who have had salary reductions will be taxed on the amount of those salary reductions. The employer should also treat those amounts as taxable income for the purposes of wage reporting on Form W-2 and for purposes of income tax, FICA, and FUTA withholding. Finally, these individuals will likely need to contribute to their benefits on a post-tax basis until such time as their participation in the plan would no longer cause a failure.

What can Plan Sponsors do to avoid a Non-discrimination Test Failure?

Robin S. Weingast and Associates, Inc. (RSW), an Employee Benefits Administration firm, has a long relationship with Albrecht, Viggiano, Zureck & Company, P.C. RSW now offers a complete Cafeteria Plan Non-discrimination Testing service. To avoid the consequences of a loss of tax-favored status, RSW recommends that Plan Sponsors test their Cafeteria Plans near the beginning of each plan year using projected contribution amounts. RSW will test the projected contributions and advise plan sponsors how to adjust actual contributions so a Non-discrimination Test failure will be averted.

What Else Should Plan Sponsors Be Doing?

Your Cafeteria Plan must be governed by a written plan document and the IRS requires you to maintain this document in compliance with current laws and regulations. If you have not had your Cafeteria Plan document updated within the last year, it may be out of compliance. RSW is offering a free review of your existing document. If the document is deficient, RSW can prepare a complete restatement to bring your Cafeteria Plan into compliance, including, at your option, adding features you might not even know were available.

For more information, please contact Robin Weingast at 516-794-1450.