Can an employer offer a different level of medical benefits to certain segments of the employee corps? What if the benefits plan is a self-funded plan under section 105 of the Internal Revenue Code? How are the nondiscrimination test and the benefits test measured in a multi-plan arrangement?
This is a very niche and technical topic, and this Freeman Law Insights blog only scratches the surface of some of the complexities involved with the relevant Code sections and Treasury Regulations, including sections 105, 125, and other.
The specific details for the proposed separate plans must be carefully evaluated for statutory eligibility and benefits purposes. The Treasury Regulations expressly allow a single self-funded plan document to be utilized for two or more separate and designated self-funded plans, provided each of them, standing alone, meet the eligibility test and the benefits test. However, there is a dearth of authority or even loose guidance that gives any comfortable level of assurance on compliance with the nondiscrimination rules of section 105(h) of the Code.
As is the case for all Insights blogs, this one is for informational purposes only; not legal advice.
Medical Benefits Plans, Very Generally
Generally, benefits provided under a plan should be uniformly available to all similarly situated individuals, and any restriction on a benefit or benefits should also apply uniformly to all similarly situated individuals. A group healthcare plan may, however, treat participants as a group of similarly situated individuals separate from beneficiaries. However, and except in rare and technical circumstances, an employment classification must not be directed at individual participants or beneficiaries based on any health factor, and under other relevant laws, benefits cannot be denied based on any protected class status.
The Treasury Regulations allow an employer to provide different benefits, including healthcare, retirement, and leave benefits, to certain segments of employees, provided there are bona fide employment-based classifications consistent with the employer’s usual business practice. Whether an employment-based classification is bona fide for these purposes is determined on the basis of all the relevant facts and circumstances. An employer who approves separate plans for separate segments of employee corps is wise to formally document distinctions and differentiations necessary to establish the bona-fide employment-based classifications and the benefits made available to the employees in each classification.
The Treasury Regulations provide examples of classifications that, based on all the relevant facts and circumstances, may be bona fide employment-based classifications, including full-time versus part-time status, different geographic location, date of hire, length of service, current employee versus former employee status, and different occupations.
See 26 C.F.R. § 54.9802-1(b)(2)(A) (addressing the permission to distinguish among different classes of similarly situated individuals), (b)(2)(B), (d), (d)(1) (examples of bona-fide classification factors), (d)(3), (d)(4), (d)(4)-Example 3 (noting a university that provides different healthcare benefits, retirement benefits, and leave benefits to faculty versus other staff would be a bona-fide employment-based classification).
Self-Funded Plans Under Section 105 of the Code
Treasury Regulation § 54.9802-1 – which permits bona-fide employment-related differentiation for benefits purposes – is not determinative with respect to compliance with section 105 that govern self-funded plans: “Compliance with this section [54.9802-1] is not determinative of compliance with any provision of . . . any other State or Federal law . . . [.] Therefore, although the rules of this section would not prohibit a plan from treating one group of similarly situated individuals differently from another (such as providing different benefit packages to current and former employees), other Federal or State laws may require that two separate groups of similarly situated individuals be treated the same for certain purposes . . . [.]” 26 C.F.R. § 54.9802-1(h).
Section 105 of the Code is “other Federal law.”
Under section 105(h)(1)-(2):
(1) In general
In the case of amounts paid to a highly compensated individual under a self-insured medical reimbursement plan which does not satisfy the requirements of paragraph (2) for a plan year, subsection (b) shall not apply to such amounts to the extent they constitute an excess reimbursement of such highly compensated individual.
(2) Prohibition of discrimination
A self-insured medical reimbursement plan satisfies the requirements of this paragraph only if –
(A) the plan does not discriminate in favor of highly compensated individuals as to eligibility to participate; and
(B) the benefits provided under the plan do not discriminate in favor of participants who are highly compensated individuals.
“For amounts reimbursed to a highly compensated individual to be fully excludable from such individual’s gross income under section 105(b), the plan must satisfy the requirements of section 105(h) and this section. Section 105(h) is not satisfied if the plan discriminates in favor of highly compensated individuals as to eligibility to participate or benefits.” 26 C.F.R. § 1.105-11(a).
The Treasury Regulations applicable to section 105(h) allow an employer to utilize a single plan document for two or more separate plans provided that (1) the employer designates the plans to be considered separately and (2) each of the separately designated plans meet the eligibility test and the benefits test of section 105(h)(2). Whether or not each proposed plan can meet those two tests is something the employer, together with the employer’s plan provider, must evaluate based on the potential eligible participants and other factors required for the testing.
Treasury Regulation § 1.105-11 provides that an employer may use a single plan document for two or more separate self-funded plans if the employer designates the plans that are to be considered separately and applicable provisions for each plan. If the single plan document is tested as two plans, each of the plans must satisfy the eligibility and benefits test of section 105(h)(2). Or, the employer may designate two or more plans as constituting a single plan for determining whether the nondiscrimination requirements are met.
Thus, if each of the separate self-funded plans are tested under section 105(h), each plan must pass the eligibility test and benefits test. The Treasury Regulation provides as follows:
Multiple plans, etc.—(i) General rule. An employer may designate two or more plans as constituting a single plan that is intended to satisfy the requirements of section 105(h)(2) [prohibition of discrimination in favor of highly compensated individuals] and paragraph (c) of this section, in which case all plans so designated shall be considered as a single plan in determining whether the requirements of such section are satisfied by each of the separate plans. A determination that the combination of plans so designated does not satisfy such requirements does not preclude a determination that one or more of such plans, considered separately, satisfies such requirements. A single plan document may be utilized by an employer for two or more separate plans, provided that the employer designates the plans that are to be considered separately and the applicable provisions of each separate plan.
26 C.F.R. § 1.105-11(c)(4)(i).
Despite a diligent search, and other than the above Treasury Regulation section 1.105-11(c)(4)(i), there appears to be a dearth of authority about whether and under what circumstances a plan, separately designated pursuant to Treasury Regulation section 1.105-11(c)(4)(i) and established in accordance with the bona fide employment classification requirements of Treasury Regulation section 54.9802-1, must be evaluated in conjunction with the other separately designated plan for purposes of determining the nondiscrimination requirements of section 105(h).
Though not legally binding or authoritative to any degree of comfortability, IRS Memorandum FREV-102945-01 (Sept. 10, 2001) dealt with a multiple self-funded plan situation and includes the following “color” relative to Treasury Regulation section 1.105-11(c)(4)(i):
However, § 1.105-11(c)(4) provides that an employer may use a single plan document for two or more separate plans if the employer designates the plans that are to be considered separately and applicable provisions of each plan. Thus, if the [X] Plan is tested as three plans (one plan for each option), each of the plans must pass the benefits test. The rule for multiple plans under § 1.105-11(c)(4) applies to both the eligibility and the benefits tests. Accordingly, if the options are tested separately for the benefits test, they would also have to be tested separately for the eligibility test.
Multiple self-funded plans were also the subject of IRS Memorandum, FREV-113006-01 (May 1, 2001), likewise a non-binding and dated memorandum.
Closing
Again, this is a very niche and technical topic. Pushing the envelope on employer health benefits plans could result in the envelope falling off the table, which can cause loss of tax benefits and application of other taxable consequences to the employer and those who participate in the applicable plans. Due care should be taken to ensure that a multi-plan regime complies with and thus can provide the tax benefits made available by the Internal Revenue Code and Treasury Regulations.
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