From the Hotline: Failing the Dependent Care FSA Non-Discrimination Test

Question: We have just been notified that we have failed the Dependent Care FSA non-discrimination testing for 2012 where non-highly compensated employees are contributing less than 55% of what the HCIs contribute. Is there a checklist or instructions on what the employer must do to fix this?

Answer: If you are working with a third party administrator (TPA) for your FSA, that firm should be able to advise you on your next steps.  In general, since the plan did not pass the non-discrimination testing, the employer/employee contributions should be counted as taxable income.

Failing the benefits test causes all reimbursements that result from the discriminatory benefits to be taxable income to highly compensated individuals (not just the amount that was determined to exceed the allowable benefit). The non-HCIs, however, would not suffer any adverse consequences, and the plan itself would not lose its qualified status as a result of failing the DCAP nondiscrimination tests.

Here is what some employers do when having difficulty passing the DCAP nondiscrimination testing to prevent or reduce the likelihood of testing failures in future years:

  • Limit HCIs’ DCAP elections during open enrollment
  • Increase and improve plan communications to help non-HCIs understand the value of DCAP participation
  • Reduce HCIs’ DCAP elections during the plan year based on preliminary and interim testing
  • Offer matching contributions to non-HCIs who participate in the DCAP

We strongly encourage you to work with your benefits attorney and/or vendor conducting the discrimination testing to determine the best next steps to reduce tax liabilities and possible penalties based on your plan.