Tax Article - Non-Discrimination Requirements

Whether medical plans are subject to any nondiscrimination rules under the Internal Revenue Code depends on how they are funded. Fully insured plans generally can discriminate as to eligibility, contributions, benefits, and so on without triggering adverse tax consequences to the participants or employer. However, to receive special tax treatment, self-insured medical expense reimbursement plans must comply with the nondiscrimination rules in Regulation 1.105-11.

Caution: In addition to the nondiscrimination rules for self-insured plans, the following nondiscrimination rules may apply to any medical plan:

a. If a medical plan is provided under a cafeteria plan, the cafeteria plan nondiscrimination rules must be followed.

Caution: This means that nondiscrimination rules apply before highly compensated and key employees can make pretax contributions for their share of medical insurance.

• Employers must ensure no discriminatory acts are committed under other laws, such as the Age Discrimination in Employment Act of 1967 (ADEA), the Civil Rights Act of 1964 (Title VII), and the Americans with Disabilities Act of 1990 (ADA).
• Employer contributions to Archer medical savings accounts and health savings accounts are subject to discrimination rules referred to as comparability rules.

b. If the plan is subject to the HIPAA portability requirements, it cannot discriminate in enrollment or premiums based on an individual’s health status.

Health Benefits for Shareholder-Employees as Constructive Dividends

A health plan exists only if it is maintained for employees. Although health plans that are not self-insured can be discriminatory, if a closely held corporation maintains a health plan that covers only shareholder-employees (or that predominantly covers only shareholder-employees), the IRS may challenge the existence of the plan by asserting it is not for employees. If successful, the IRS may treat the corporation’s premium payments for shareholder-employees, together with medical care reimbursements received by them, as constructive dividends. Such a dividend is nondeductible by the corporation and taxable to the shareholder-employees.

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