Non‑Discrimination Testing for 125 Plan
What Is Section 125 Plan Non-Discrimination Testing?
Non-discrimination testing for Section 125 Plans is essential to ensure that these tax-saving benefits are applied fairly across all employees. The IRS requires businesses to conduct these tests annually to prevent favoring highly compensated employees, key management, or owners. Non-discrimination tests help keep your plan compliant and prevent penalties.
If you’re offering a Section 125 Plan, it’s important to understand these requirements. Conducting regular non-discrimination testing ensures your business can provide valuable benefits without risking compliance issues. This article explains the non-discrimination testing requirements and how they impact your business and employees.
Why Non-Discrimination Testing Matters
Non-discrimination testing helps ensure that Section 125 Plans do not disproportionately benefit higher-paid employees. Without these tests, businesses could risk the IRS disallowing the tax advantages that come with offering a Section 125 Plan. Here’s why this is important:
Ensures Fairness: Non-discrimination tests make sure that benefits are available to all employees, not just highly compensated ones.
Prevents Penalties: Failure to comply with non-discrimination rules could lead to costly penalties and loss of tax benefits.
Maintains Compliance: Regular testing keeps your plan compliant with IRS regulations, helping you avoid legal trouble.
Regular non-discrimination testing keeps your Section 125 Plan in line with IRS rules, ensuring it benefits all employees equally.
Types of Non-Discrimination Tests
The IRS requires businesses to perform several tests to make sure their Section 125 Plan complies with non-discrimination rules. These tests evaluate whether the benefits provided to employees are available equally to all workers, regardless of their pay scale or position.
1. Eligibility Test
This test checks whether the eligibility rules for your Section 125 Plan apply equally to all employees. To pass the eligibility test, employees must have an equal opportunity to participate in the plan, and the criteria for participation cannot favor higher-compensated employees.
2. Benefits Test
The benefits test ensures that the benefits provided through the Section 125 Plan are made available to all employees. For example, if health insurance premiums are paid with pre-tax dollars, they must be available to all employees, not just executives or highly-paid workers.
3. Contribution Test
This test checks whether contributions made by employees to the Section 125 Plan are fair across all income levels. It helps ensure that employees of all income levels can participate without discrimination. Higher-paid employees should not be able to contribute a significantly higher percentage of their income compared to lower-paid employees.
Passing the eligibility, benefits, and contribution tests ensures your Section 125 Plan is fair and compliant with IRS regulations.
How to Conduct Non-Discrimination Testing
Conducting non-discrimination testing involves analyzing your employee population and comparing the benefits, eligibility, and contributions across different income groups. While the IRS sets the rules, you will need a qualified third-party administrator (TPA) to help you conduct these tests. Here’s how to comply with Section 125 non-discrimination testing requirements:
Step 1: Gather Data
Before you can perform non-discrimination testing, you’ll need to gather data on employee compensation, contributions, and benefits. This includes knowing how much each employee is contributing and which benefits they are receiving.
Step 2: Perform the Tests
To ensure fairness, a third-party administrator (TPA) will perform the eligibility, benefits, and contribution tests on your Section 125 plan. They’ll compare the benefits provided to employees of different income levels to ensure that they meet IRS standards.
Step 3: Correct Any Issues
If your plan fails any of these tests, your TPA will help you make adjustments. This could involve changing eligibility rules, adjusting benefits distributions, or altering employee contribution levels. The goal is to ensure that your plan is compliant and fair for all employees.
Common Reasons Plans Fail (And How to Fix Them)
Non-discrimination testing isn’t hard—but small mistakes can cause big problems. Here are the most common issues we help employers avoid:
Too Many Executives Participating
- Fix: Encourage more rank-and-file employees to enroll. We’ll help with communications and FAQs that drive participation.
Unequal Access to Benefits
- Fix: Make sure every eligible employee has access to the same pre-tax benefit elections. We’ll review your plan documents to ensure fairness.
Late or Missing Annual Testing
- Fix: We send testing reminders and handle the process for you—on time, every year.
Disclaimer: Section 125 Solutions LLC does not provide legal or tax advice. We act as a referral partner to third-party administrators who are fully qualified to implement and manage compliant Section 125 Cafeteria plans.
Want to See What You Could Save?
Wondering if your current benefits setup meets IRS requirements? Use our quick calculator to check your compliance risk and estimate potential FICA savings from a properly balanced 125 Plan.
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Disclaimer: Calculations provided are for informational purposes only and do not guarantee specific savings. Actual savings will vary based on individual circumstances.
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Explore how Section 125 plans could save your business over $1,000 per W-2 employee each year. Book a free consultation to see how much you could be losing by not having one.
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