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Cafeteria Plan - Key Employee Concentration Non-Discrimination Test

Posted on May 10th, 2023

The Internal Revenue Service (IRS) requires employers who sponsor a Cafeteria Plan (sometimes called a Section 125 Plan or Premium-only-Plan) to conduct certain non-discrimination tests. Because a Cafeteria Plan provides tax-free benefits, the IRS has rules in place so that tax-free benefits are not provided or elected more favorably to employees who are considered key employees. This is referred to as the Key Employee Concentration Non-Discrimination Test.

A key employee is defined as:

An officer of the company who earned a specified dollar amount in the prior plan year. For 2023 plan years, officers who earned $200,000 or more in 2022 are considered key employees. For 2024 plan years, officers who earned $215,000 or more in 2023 are considered key employees. It should be noted that no more than 50 employees shall be treated as officers (or, if lesser, the greater of 3 employees or 10% of the employees).
Anyone who owned more than 5% of the company in the prior plan year regardless of actual compensation; or
Anyone who owned more than 1% of the company and earned $150,000 (not indexed) or more in the prior plan year.

Key employees cannot make up more than 25% of all elected benefits in a Cafeteria Plan or this non-discrimination test will be failed. If the test is failed, key employees must either reduce their pre-tax elected benefits to the 25% threshold, or they cannot participate in the Cafeteria Plan. It is up to the employer to decide which key employees must reduce their pre-tax elections and by how much if the key employee concentration test is failed. The formula is simple to calculate, and employers should include both employee and employer contributions when determining the total elections.

Formula = Total elections by key employees ÷ Total elections by all key and non-key employees

After performing this calculation, the percentage should be 25% or less to pass this non-discrimination test.

Note: Common benefits offered under a Cafeteria Plan may include health, dental, vision, life, disability, Health FSAs, Dependent Care FSAs, and HSAs. All benefits offered under a Cafeteria Plan should be included when determining the total elections. Cafeteria Plans also have two other non-discrimination tests that must be conducted – the Eligibility Test and the Contributions and Benefits Test.


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