Employers often provide an array of benefits to employees. One such benefit is a Health Flexible Spending Account (Health FSA). These accounts allow employees to contribute pre-tax dollars to be used for unreimbursed medical expenses incurred during the year. Health FSAs are considered self-funded health plans and must not discriminate in favor of highly compensated employees.
Employers often think having a non-discriminatory eligibility policy allowing all full-time employees to participate if they choose is sufficient to comply with non-discrimination requirements; however, it is much more complicated. An employer’s health FSA can violate the non-discrimination requirements, even though any employee is eligible to participate, if highly compensated employees participate in greater numbers than non-highly compensated employees.
Because highly compensated employees typically have more discretionary income and are more likely to be looking for ways to reduce their taxable income, these employees are more likely to participate in health FSAs than employees in lower income brackets. When a higher proportion of highly compensated employees participate in the Health FSA than non-highly compensated employees the employer’s health FSA can violate the non-discrimination rules even though the employer offered the benefit on a nondiscriminatory basis. The result of a discriminatory health FSA is a loss of tax benefits to the highly compensated employees and penalties for employers...
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