By Sheldon M. Geller, Esq., Geller & Wind, Ltd.

As a result of the repeal of Sec. 89, the pre-TRA 86 rules were generally reinstated for plan years beginning after 1988. Insured health plans are not subject to any nondiscrimination rules (unless provided through a cafeteria plan or a Sec. 501(c)(9) trust). Accordingly, insurance coverage provided by Blue Cross/Blue Shield and private carriers are therefore not subject to any nondiscrimination rules. Funded and non-funded self-insured medical reimbursement plans are subject to nondiscrimination rules.

Health Plans

A self-insured medical reimbursement plan must not discriminate in favor of highly-compensated individuals as to benefits and eligibility to participate. Further, the plan must not operate in such a fashion as to discriminate in favor of highly-compensated individuals.

In order to be nondiscriminating as to eligibility to participate, a self-insured medical reimbursement plan must satisfy either a percentage test or a classification test. The percentage test requires generally that the plan benefit 70% or more of the employer's nonexcludable employees. The classification test requires that the plan benefit employees that qualify under a classification set up by the employer and found by the IRS not to be discriminatory. A self-insured medical reimbursement plan will meet the benefits test if all benefits provided to highly-compensated individuals who are participants are also provided to all other participants.

A plan may include a wide range of benefits, and each individual self- insured benefit (e.g., dental, vision) may be considered a separate plan. An employer may designate two or more self-insured medical reimbursement plans as a single plan for purposes of satisfying the nondiscrimination test.

Treasury regulations indicate that an employee's annual physical examination conducted at the office of the employee's physician is not part of a self-insured medical reimbursement plan. Therefore, executive- only physical examination programs are not considered discriminatory.

If a self-insured medical reimbursement plan is discriminatory, the excess reimbursements will be taxable to highly-compensated individuals only.

Group Term Life Insurance Plans

Employees must include in gross income the cost of employer-provided group term life insurance exceeding $50,000. The cost is determined in accordance with Treasury regulations and is reduced by any employee after-tax contributions. Further, group term life insurance plans may not discriminate in favor of key employees as to eligibility to participate and in the type and amount of benefits available under the plan. All policies maintained by the employer providing group term life insurance to employees are treated as a single plan. If a group term life insurance plan discriminates, the cost of the greater of the actual cost or the Treasury regulation cost of the first $50,000 of coverage is includible in the gross income of key employees.

Cafeteria Plans

A cafeteria plan may not discriminate in favor of highly compensated individuals and, therefore, must satisfy eligibility, benefits and concentration tests. In order to meet the concentration test, nontaxable benefits provided to key employees cannot exceed 25% of all nontaxable benefits provided to all participants. A cafeteria plan providing health benefits will satisfy a certain nondiscrimination test if: 1) contributions on behalf of each participant include an amount equal to 100% of the cost of health coverage elected by a majority of the highly- compensated participants who are similarly situated (e.g., those with family coverage) or at least equal to 75% of the cost of health coverage of the participant with the highest cost health coverage under the plan; and 2) contributions or benefits under the plan exceeding those described above have a uniform relationship to compensation.

If a cafeteria plan is found to be discriminatory, the highly compensated individuals (or key employees, if the concentration test fails) will have the value of the otherwise tax-free benefits provided under the plan included in their gross incomes.

Dependent Care Assistance Plans

In order to be nondiscriminatory, a dependent care assistance plan (DCAP) may not discriminate in favor of highly-compensated employees (or their dependents) as to eligibility to participate or as to contributions or benefits and must satisfy a concentration test.

DCAPs satisfy the eligibility, contributions, and benefits tests if they do not discriminate in favor of highly-compensated employees or their dependents after excluding employees who have not attained age 21 and completed one year of service and certain union employees.

DCAPs satisfy the concentration test if no more than 25% of the amount paid or incurred by the employer for dependent care assistance is provided to 5% owners (or their spouses or dependents) of the employer.

If a DCAP fails any of these nondiscrimination tests, highly- compensated employees will be taxed on all of the dependent care assistance benefits they received during a calendar year. Non-highly compensated employees will not be affected.

Sec. 501(c)(9) Trusts

There are general nondiscrimination requirements governing welfare benefits (e.g., insured health benefits) funded through a Sec. 501(c)(9) trust known as a voluntary employees' beneficiary association (VEBA). Each type of benefit funded through the trust must be provided to a classification of employees that does not discriminate in favor of highly-compensated employees. However, if the benefit provided through the trust has its own nondiscrimination requirements, then the requirements for that benefit must be satisfied in lieu of the Sec. 501(c)(9) general nondiscrimination rules.

If a Sec. 501(c)(9) trust provides benefits in a discriminatory manner, the trust will lose its tax-exempt status, and the employer will be subject to a 100% excise tax on the disqualified benefits.

Welfare Benefit Plans: Compliance Requirements

Treasury regulations and ERISA require self-insured medical reimbursements, group term life plans, cafeteria plans, and dependent care assistance plans to have separate written plan documents, including summary plan descriptions for participants and to be maintained for the exclusive benefit of employees.

Further, cafeteria plans have to be amended to comply with recent Treasury regulations, particularly for health care reimbursement programs. Commencing in 1990 plan years, the maximum amount of reimbursement under a health flexible spending account (FSA) at any point in time may not be based upon the amount of "premiums" or salary redirections that an individual has paid at any point in time. The maximum amount of benefits must be available at all times during the period of coverage. For example, assume a participant elects to defer $1,200 of salary, or $100 per month and incurs a claim for the full $1,200 in February. Despite the fact that the level of funding at the time of the claim is only $200, the employer would be required to pre- fund the balance of the claim. Thus, all cafeteria plans including health FSAs must be redrafted to include these new provisions and possibly incorporate design features that would protect the employer from significant risk of loss. Participants must be notified of their available dependent care benefits.

There is no specific plan document or notification requirements for group term life insurance plans. Benefits under these plans may only be provided to employees and retirees.

Editors: Sheldon M. Geller, Esq. Geller & Wind, Ltd. John F. Rafferty, Jr., CPA Own Account Contributing Editor: David Wasserstrum, CPA Ernst & Young