QUICK REFERENCE CHART: Nondiscrimination Rules

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Section 125/Cafeteria Plans, Section 105 (for Self-Insured Plans/HRAs/Health FSAs), Dependent Care FSAs and
Group Term Life Insurance


At a high level, under general federal income taxation principles, compensation in any form that is paid or provided by an employer to an employee constitutes taxable income (wages), unless a section of the Internal Revenue Code (IRC) provides a specific exclusion from income. Several IRC sections include exclusions for certain employer-provided benefits. Those include group term life insurance (Section 79), self-insured health benefits, including HRAs and health FSAs (Section 105), and dependent care FSAs, also called dependent care assistance programs (DCAPs) (Section 129). In addition, qualified benefits offered through a cafeteria plan (e.g., pre-tax salary reduction contributions towards health insurance premiums or a health FSA) qualify for an income tax exclusion (Section 125).

That said, each of those IRC sections comes with some strings attached. Of primary importance are the so-called nondiscrimination rules, which are meant to discourage employers from providing tax-favored benefits disproportionately to executives and other highly compensated employees (HCEs). To satisfy the IRS, employers that rely on income exclusion rules must demonstrate, through nondiscrimination testing, that the benefit plan design does not intentionally or unintentionally favor HCEs. While the nondiscrimination rules and testing procedures are not uniform for every plan or benefit type, they share the following elements:

  • A prohibited group of individuals (HCEs or key employees) in whose favor the plan cannot discriminate
  • Categories of employees who can be excluded from testing
  • An eligibility test to ensure that a sufficient number of non-HCEs are eligible to participate in the plan or benefit
  • A benefits and contributions test to ensure that HCEs/key employees are not receiving benefits and/or employer contributions on more favorable terms than non-HCEs/key employees
  • A utilization test to ensure that HCEs/key employees are not disproportionately benefiting from the plan
  • Adverse tax consequences in the event that the plan fails a required nondiscrimination test


The Quick Reference Chart on the next page outlines the component nondiscrimination test for each IRC section and the corresponding HCE or key employee definitions. As a technical matter, Section 105 uses the term “highly compensated individuals” (HCIs) to describe the parties in whose favor the plan cannot discriminate, whereas other IRC sections use the term “highly compensated employees” (HCEs). In practice, the terms are often used interchangeably except where specific distinctions between the two are material to the discussion. For readability, this publication uses HCE throughout.

Quick Reference Chart: Nondiscrimination Rules

Plan Type IRC Section Component Tests Compensation/Definition for Determining HCE/Key Employee Status
Section 125/Cafeteria Plans (including premium-only plans (POPs), health FSAs and employer/employee contributions to an HSA) Section 125 Eligibility Test
Contribution & Benefits Test
Key Employee Concentration Test
Any officer
More-than-5% shareholder/owner
Any employee with compensation in excess of the indexed threshold ($130K for 2021; $135K for 2022)
Key Employee:
Officer with compensation in excess of the specified threshold ($185K for 2021; $200K for 2022)
More-than-1% shareholder/owner with compensation in excess of $150K (not indexed)
Self-Insured Group Health Plans (including HRAs and health FSAs) Section 105 Eligibility Test
Benefits Test
Top-5-paid officer
More-than-10% shareholder/owner
25% highest paid employee group
Dependent Care FSAs (also called dependent care assistance programs, or DCAPs) Section 129 Eligibility Test
Benefits Test
More-than-5% Owner Concentration Test
55% Average Benefits Test
Employee with compensation in excess of the indexed threshold ($130K for 2021; $135K for 2022)
Group Term Life Insurance (GTLI) Section 79 Eligibility Test
Benefits Test
Key Employee:
Officer with annual compensation in excess of the specified threshold ($185K for 2021; $200K for 2022)
More-than-5% owner/shareholder
More-than-1% owner with compensation in excess of $150K