FSA Nondiscrimination Testing

Employers who offer a Flexible Spending Account option for their workforce should also be mindful of certain instances in which some employees will be ineligible to participate in the plan.  This type of ineligibility is based on nondiscrimination testing that is conducted annually to ensure the plan is complying with IRS regulations.  To better help employers understand FSA nondiscrimination testing, here are insights into the compliance services and testing that are a part of P&A’s FSA plan administration.

What is Nondiscrimination Testing (NDT) for an FSA?

FSA nondiscrimination testing is used to ensure the plan is not favoring highly compensated employees.  There are a series of tests that must be performed annually to determine this.  The tests pertain to participation in a Health FSA or Dependent Care FSA.

Types of FSA Nondiscrimination Testing

Eligibility Test

The eligibility test is used when initially creating the plan, so employers will know if they can even offer an FSA plan to their workforce.  The eligibility test must confirm two points:

• More than 70% of employees must be eligible to participate in the plan.
• The plan does not favor highly compensated employees who are defined as: one of the five highest paid officers; more than a 10% shareholder; one of the highest paid 25% of all employees.

Benefits Test

Like the eligibility test, the benefits test is performed when creating the FSA plan.  This test looks at the benefits available to all employees.  To pass, the benefits available to Highly Compensated Employees must also be offered to all plan participants.  Additionally, the maximum benefits offered cannot be dependent on compensation, age or years of service.

Key Employee Concentration Test

This test examines whether any key employees are participating in an FSA.  Under IRS rules, key employees cannot receive more than 25% of all non-taxable benefits offered through the plan.  Key employees are defined as:

• Officers with an annual compensation greater than a certain dollar amount in the prior plan year ($230,000 2024 salary for 2025 testing).
• More than 5% owners.
• More than 1% owners with annual compensation over $150,000 in the prior calendar year (2024 salary for 2025 testing).

However, there are other factors that are also considered when performing the test.  For instance, if employees contribute anything toward their health insurance, the whole premium amount is used in the test, not just the employee contribution.  Also, unlike other tests, the key employee concentration test looks at data from the prior plan year for testing in the current year.

Automatic pass:  if your plan simply doesn’t contain any key employees, then the plan automatically passes.

Dependent Care Testing

While the eligibility test and benefits test as outlined above also apply to Dependent Care Accounts, there are two additional tests that must be performed for participants who are enrolled in a Dependent Care FSA.

5% Owners Concentration Test

To pass this test, Dependent Care FSA participation must show that:

• No more than 5% of shareholders or owners (including spouses and dependents) make up more than 25% of the total dependent care account election.

Automatic pass:  If there are no 5% shareholders who participate in the Dependent Care FSA, then the plan automatically passes.

55% Average Benefits Test

This test determines if the average benefits offered to non-highly compensated employees is at least 55% of the average benefits provided to highly compensated employees.  A highly compensated employee is defined as:

• A 5% owner of the employer in the preceding calendar year.
• Employees whose compensation for the preceding calendar year is more than $155,000 (2024 wages for 2025 testing).

Automatic pass:  If there are no highly compensated employees participating in the Dependent Care FSA, the plan automatically passes.

What to Do If Your Plan Fails Testing

P&A will notify the employer directly if any of the tests fail.  We work with employers to determine the best course of action so the plan passes testing.

Testing can seem confusing.  That’s why P&A’s team of experts is here to perform the testing and make sure your FSA is IRS compliant.  For calendar plan years, testing is performed within the first quarter of the year.  Should you have any questions about FSA nondiscrimination testing or the process of testing the plan, please submit an inquiry to PA&’s Benefit Consultants and a member of our team will connect with you directly.

Contact a Benefits Consultant