Cafeteria Plan Discrimination Testing Requirements

Federal Tax Law requires that cafeteria plans do not discriminate in favor of highly compensated employees as to eligibility to participate (test 1) and contribution & benefits provided (test 2). It must also not discriminate in favor of key employees as to concentration of benefits. (25% test) (test 3). Failure to meet the nondiscrimination requirements of Section 125 would eliminate the tax-free status of the benefits provided to highly compensated and/or key employees.

The plan must satisfy all three of the test mentioned above. If your plan offers all employees the opportunity to participate, and gives all employees the same contributions and benefits, then generally the plan will pass the first two of these test. However, if the employer’s contributions and benefits are not equal for all employees, or if the contributions favor highly compensated or key employees, then your plan could violate the non-discrimination requirements. Even if the contributions and benefits are equal for all employees, the plan could still fail the 25% key employee concentration test if a disproportionate number of highly compensated or key employees elect the benefits.

If the plan excludes some employees from participating, the plan may violate the non-discrimination rules as to eligibility to participate. Exclusion of a classification of employee must be reasonable and must be established under objective business criteria that identify the classification of employees who benefit under the plan. Reasonable classifications include specified job categories, nature of compensation (i.e., salaried or hourly), geographic location and similar bona fide business criteria. A classification is not discriminatory if, and only if, the employees benefiting under the plan satisfy either a “safe harbor” percentage test or the “facts and circumstances” test for the plan year.

An IRC 125 25% “key Employee” worksheet If you suspect your plan may be in violation of other non-discrimination rules as described above please contact Worksite Benefit Plans, Inc. or your tax and/or legal advisors for assistance.

25% Concentration Testing Instructions

Step 1: Identify Key Employees

A key employee is any employee, who, for the current or four preceding years falls into any of the categories below:

a)An officer of the company receiving more than $135,000 annual compensation, or

b)A more than 5 percent owner of the company, or

c)A more than 1 percent owner receiving more than $150,000 annual compensation.

Step 2: Calculate the total non-taxable $ contributed by key employees (A) ______

Step 3: Calculate the total non-taxable $ contributed by all employees (B) ______

Step 4: Calculate the % of contributions contributed by Key employees (A/B) ______%

Conclusion: If the % calculated in step 4 is greater than 25% then the plan is discriminatory and key employees must make adjustments in their contributions to bring the plan into compliance.

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