Most health plans are subject to some nondiscrimination rules as there are many varied rules that prohibit favoring highly-compensated individuals or prohibit discriminating against those with high-cost claims or eligibility for Medicare or TRICARE. The Affordable Care Act (ACA) included a provision that would also apply nondiscrimination rules applicable to self-funded plans to fully insured plans. For more details on rules applicable to self-funded health plans, see the Leavitt Group article Nondiscrimination Rules for Self-funded Plans. The Affordable Care Act’s (ACA) nondiscrimination rules for non-grandfathered, fully insured group health plans that were to take effect in 2010 have been delayed indefinitely, pending the issuance of regulations from the Internal Revenue Service(IRS). For full details, see the prior Leavitt Group article IRS Issues Notice 2011-1, Delaying the Effective Date of Nondiscrimination Rules for Insured Group Health Plans. In order to provide insured group health plan sponsors time to implement any changes required as a result of the regulations or other guidance, it is anticipated that the guidance will not apply until plan years beginning a specified period after it is issued.
Summary
The IRS has not issued regulations or any new or additional information on the ACA’s nondiscrimination rules for fully insured group health plans. If there are pre-tax premiums offered through an IRC section 125 Cafeteria Plan, a nondiscrimination will still apply, though different from the one the ACA intends to apply. See below for a simple explanation of the IRC section 125 nondiscrimination rule. For fully insured plans that are 100% employer paid, with no pre-tax premiums, the nondiscrimination rule prohibiting favoring Highly Compensated Individuals (HCI) does not apply, affording employers more flexibility in offering coverage. Rules prohibiting discrimination against Medicare-eligible individuals still apply for groups with 20 or more employees, as does rules under the Health Insurance Portability and Accountability Act (HIPAA) prohibiting discrimination against those with high-cost claims. Be sure to work with your Leavitt Group Trusted Advisor to ensure compliance with all of the various nondiscrimination rules that may apply to your plan.
Section 125 Cafeteria Plan Nondiscrimination Rules
Although fully insured plans are not currently subject to the ACA’s nondiscrimination requirements, health benefits offered as part of a cafeteria plan generally will be subject to the nondiscrimination requirements of Internal Revenue Code Section 125.Because cafeteria plans offer tax advantages to employers and participants, these plans must meet certain nondiscrimination requirements to ensure that HCIs do not receive a disproportionate amount of tax-advantaged benefits. Specifically, a cafeteria plan must not discriminate in favor of:
- HCIs as to eligibility to participate (the eligibility test);
- HCIs as to contributions and benefits (the contributions and benefits test); or
- Key employees as to concentration of benefits (the key employee concentration test).
If a cafeteria plan is discriminatory, all HCI or key employee participants will face adverse tax consequences. An employee is a HCI if their compensation is in excess of a specific dollar threshold the preceding year ($150,000 for plan year 2023 or $155,000 for 2024). This threshold changes nearly annually. See the prior IRS Notice setting the 2024 threshold.
For full details on Cafeteria Plan nondiscrimination testing, see the Leavitt Group article Nondiscrimination Tests for Cafeteria Plans.
ACA Nondiscrimination Rules
While the nondiscrimination rules under the ACA for non-grandfathered, fully insured plans are not being enforced at this time, if and when regulations are issued, these plans will have to satisfy requirements similar to those in Internal Revenue Code(Code) Section 105(h)(2), prohibiting discrimination in favor of HCIs. This provision generally provides that plans must pass two separate nondiscrimination tests—the eligibility test and the benefits test.
An HCI for purposes of these rules is an individual who is:
- One of the five highest paid officers;
- A shareholder who owns more than 10% in value of the stock of the employer; or
- One of the highest paid 25% of all employees (other than an employee excludable as described below).
For nondiscrimination testing purposes, the Code generally treats two or more employers as a single employer if there is sufficient common ownership or a combination of joint ownership and common activity. The controlled group and affiliated service group rules of Code Sections 414(b), (c) and (m) are expressly applied to nondiscrimination testing under Code Section105(h)(2).
Eligibility Test
To pass the eligibility test, a plan must benefit one of the following:
- At least 70% of all employees;
- At least 80% of all employees who are eligible to benefit under the plan (if at least 70% of all employees are eligible to participate in the plan); or
- A nondiscriminatory classification of employees.
In order to have a nondiscriminatory classification of employees, there must be a bona fide business reason for the classification and a sufficient ratio of non-HCIs must benefit. Examples of reasonable classifications generally include specified job categories, compensation categories (such as hourly or salaried) and geographic location.
In running the eligibility test, an employer may exclude from consideration employees who:
- Have not completed three years of service;
- Have not attained age 25;
- Are part-time or seasonal;
- Are collectively bargained; or
- Are non-resident aliens who do not receive U.S. earned income.
Benefits Test
To pass the benefits test, all benefits provided to the HCIs who participate in the plan must be provided to all other participants as well. Also, all the benefits available for the dependents of HCIs must be available on the same basis for dependents of all other participants. The regulations and IRS guidance indicate that the level of employer contributions should not discriminate in favor of HCIs.
A plan may have a maximum reimbursement limit for any single benefit or combination of benefits, but the maximum limit attributable to employer contributions must be uniform for all participants and their dependents. The limit may not be modified due to a participant’s age or years of service.
There are two components to the benefits test. A plan must not:
- Discriminate on its face in providing benefits in favor of HCIs; or
- Discriminate in favor of HCIs in actual operation (determined on a facts and circumstances basis).
A plan will discriminate on its face if the plan document contains discriminatory provisions that favor HCIs. A plan could discriminate in operation if it is amended or terminated so that the duration of the plan (or benefit) favors HCIs, or if the plan approves certain claims for medical expenses for HCIs but denies them for non-HCIs without a permissible reason for treating them differently. However, a plan will not be considered discriminatory just because HCIs participating in the plan use a broad range of plan benefits to a greater extent than do other employees participating in the plan.
ACA Nondiscrimination Rules Delayed Pending Regulations
The IRS issued Notice 2011-1 in December 2010, delaying the application of the nondiscrimination rules to insured group health plans until after regulations are issued. In Notice 2011-1, the IRS acknowledged that employers would have difficulty complying with the nondiscrimination rules without regulatory guidance. In particular, one provision of the law states that insured plans must follow rules “similar to” the rules found in Code section 105(h)(3), (4) and (8). This reference means that guidance must specify how insured plans should follow those rules, since the law itself is unclear on this point.
As stated above, compliance with the nondiscrimination rules will not be required until after regulations (or other administrative guidance) is issued. In order to give employers time to implement any required changes, the guidance is expected to apply to plan years beginning a certain amount of time after the guidance is issued.
The IRS has not yet released any further guidance on this issue. Thus, the nondiscrimination requirement for fully insured plans continues to be delayed indefinitely.
Source: Zywave. Republished with permission. Some content by Leavitt Group. The content of this advisory is not intended to be legal or tax advice. Consult with your own legal and tax professional to ensure compliance with all applicable law.