What Is Section 105(h) Testing for Self-Insured Health Plans?

Self-insured health plans are subject to Section 105(h) of the Internal Revenue Code, which prohibits discriminatory practices in offering plan benefits. Section 105(h) testing is the process employers use to verify compliance with these non-discrimination rules. The goal is to ensure that self-insured health plans do not disproportionately favor highly compensated individuals (HCIs) in terms of eligibility or benefits offered.

To pass the test, a self-insured plan must meet two key criteria: the eligibility test and the benefits test. The eligibility test evaluates whether enough non-HCIs are covered under the plan. This requires an assessment of the percentage of all employees who are eligible and compares it to specific minimum participation thresholds. The benefits test ensures that the level of benefits offered to all participants is uniform and does not provide richer benefits to HCIs.

Highly compensated individuals are generally defined as employees who are officers, shareholders owning more than 10% of the company, or among the highest-paid 25% of employees. If the plan fails either test, HCIs could face tax implications, as their benefits would be included in taxable income. This could significantly reduce the tax advantages of participating in a self-insured plan for these individuals.

Employers are responsible for conducting Section 105(h) testing at least annually or whenever there are significant plan changes. Failure to comply with these rules could result in audits and penalties from the IRS. Many organizations rely on third-party administrators or consultants to conduct these tests accurately and ensure ongoing compliance.

Maintaining compliance with Section 105(h) helps protect the tax-advantaged status of benefits under a self-insured health plan. It also aligns with broader principles of fairness and inclusivity in employee benefit offerings. Employers should integrate this testing into their fiduciary process to minimize risk and uphold their responsibilities.

References

1. Internal Revenue Code § 105(h). Retrieved from https://www.law.cornell.edu/uscode/text/26/105
2. U.S. Department of the Treasury. (n.d.). Nondiscrimination Rules for Self-Insured Plans. Retrieved from https://www.irs.gov/pub/irs-tege/fringe_benefit_fslg.pdf
3. Employee Benefits Security Administration. (2022). Compliance Assistance for Employee Benefits. Retrieved from https://www.dol.gov/agencies/ebsa/employers-and-advisers/compliance-assistance

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