Many employers offer a Flexible Spending Account (FSA) for Dependent Care, but did you know that this benefit is the most likely to fail non-discrimination testing under the IRC Section 129(d)?
These spending accounts are typically used by more highly compensated employees (HCEs) than non-highly compensated employees (NCHEs). And this means many of these plans fail the 55% Average Benefits Test ― which essentially requires that 55% of the average benefits must be contributed by non-highly compensated employees (all NHCEs considered for the average, not just those that contribute).
What’s the risk here?
Has anyone ever been fined for not complying with these regulations? The simple answer is “no” (at least, not that we are aware of). Health and welfare nondiscrimination testing hasn’t been a heavy target in DOL health and welfare plan audits. However, it is still wise to test these plans in case the DOL does actually decide to start policing this requirement.
The DOL goes as far as raising the issue in its published guide, Self-Compliance Tool for Part 7 of ERISA: Health Care-Related Provisions. Of course, if you have a discriminatory pre-tax benefit (like the Dependent Care FSA) that favors HCEs, you are under-reporting taxable income to the HCEs.
Playing it Safe
Here’s what to do if you don’t want to take the risk.
- Limit the Dependent Care FSA benefit to only those considered NHCEs (salary under $125,000 for 2019, not an officer or greater than 5% owner).
- Conduct 2019 nondiscrimination testing for your population early in the year (Spring 2019 is a great time!).
- Ensure that the Eligibility and Benefits tests are also conducted.
- Confirm all your employee groups are considered for testing if your population consists of multiple controlled groups.
If your plan is not in compliance, you can proactively stop 2019 contributions by HCEs. If shut off in time, your 2019 Dependent Care FSA plan will pass the 55% Average Benefits Test. If not caught in time, you can process refunds to the HCEs or treat the remainder of their plan benefits as taxable income.