August 24, 2010

HRB 15 - Salary-based Discrimination Rules Applicable to Fully Insured Group Health Plans

Released August 24, 2010I Download as a PDF

August 24, 2010 -- Among the myriad provisions of the Patient Protection and Affordable Care Act, lies a sleeping python. It is in the form of salary-based discrimination rules that are extended to fully insured group health plans.

Historically, fully insured group health plans have not been subject to salary-based discrimination rules. They have, of course, been subject to Title VII-type discrimination rules, such as age, gender, disability, pregnancy, etc.; but, beyond that, employers have had broad discretion to define benefit eligibility and availability in the manner that they choose.

Beginning at the first plan year on or after September 23, 2010, non-grandfathered plans, or plans that have lost grandfathered status, will be subject to rules that prohibit employers from providing better benefits to, roughly, the top 25% of employees, based on pay. In summary, there is a penalty imposed if highly paid individuals, as defined below, receive a better contribution, or a better benefit, than the rank and file employees. A couple common ways that a plan could discriminate are:

  • If the employer contributes a higher percentage of premium for owners, officers, shareholders, or the top 25% of its highly paid employees (not including Excludable Employees, as described below);
  • If the employer offers several benefit options, and a disproportionate number of highly-paid individuals select plans providing a richer benefit; or
  • Offering a particular treatment only to highly paid employees.

Overview of the IRC §105(h) Rules

According to the IRC §105(h) rules, a fully insured plan must pass an Eligibility Test, and a Benefits Test.

Eligibility Test

The fully insured plan must pass one of the following tests:

  1. The plan must benefit 70% or more of all employees.
  2. Seventy percent or more of all employees must be eligible to participate in the plan and of those eligible to participate, at least 80% must benefit under the plan.
  3. The plan may benefit a classification of employees established by the employer, so long as the classification is not discriminatory in favor of highly paid individuals. The IRS must be satisfied that this classification is nondiscriminatory. This determination is made on a facts-and-circumstances basis.

Excludable Employees

Certain employees may be excluded from Tests 1 and 2, above. These include:

  • Part-time or seasonal employees, i.e., those working fewer than 35 hours, or nine months in a year, if regular employees work substantially more than that.
  • Employees covered by a collective bargaining agreement where health benefits have been the subject of good faith bargaining.
  • Employees who have been employed for less than three years.
  • Employees who are under age 25.
  • Nonresident aliens with no U.S. source of income.

For purposes of the discrimination rules:

  • The control group rules apply.
  • A highly paid individual is one of the following:
    • An individual among the five highest-paid officers.
    • A shareholder owning more than 10% in value of the employer’s stock.
    • An individual among the highest-paid 25% of all employees other than Excludable Employees, as described above.

Benefits Test

In order to pass these nondiscrimination tests, both the highly paid individuals and non-highly paid individuals must be provided with the same benefits. A plan may be found to be discriminatory, as to benefits, if:

  • The highly paid individuals receive benefits not available to non-highly paid individuals;
  • The benefits are in proportion to compensation; or,
  • The benefits otherwise discriminate in favor of the highly paid individuals.

Excepted Benefits

The preamble to the grandfathered health plan regulations provides that the insurance provisions of the PPACA will not apply to HIPAA-exempt programs, such as limited scope dental and vision plans. In addition, these rules do not apply to stand alone retiree-only plans, i.e., those plans covering no active employees.

Consequences of a Discriminatory Plan

The consequence of a discriminatory insured plan comes in the form of an excise tax equaling $100 a day per affected employee, with a maximum penalty of $500,000. Because of the onerous nature of this penalty, employers will want to be very careful about losing grandfathered status.


About the Author: Karen R. McLeese is Vice President of Employee Benefit Regulatory Affairs for CBIZ Benefits & Insurance Services, Inc., a division of CBIZ, Inc. She serves as in-house counsel, with particular emphasis on monitoring and interpreting state and federal employee benefits law. Ms. McLeese is based in the CBIZ Leawood, Kansas office.


The information contained herein is not intended to be legal, accounting, or other professional advice, nor are these comments directed to specific situations. The information contained herein is provided as general guidance and may be affected by changes in law or regulation. This information is not intended to replace or substitute for accounting or other professional advice. You must consult your own attorney or tax advisor for assistance in specific situations. This information is provided as-is, with no warranties of any kind. CBIZ shall not be liable for any damages whatsoever in connection with its use and assumes no obligation to inform the reader of any changes in laws or other factors that could affect the information contained herein. As required by U.S. Treasury rules, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained herein is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding any penalties that may be imposed by the Internal Revenue Service.

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