Non-Discrimination Testing Guide for Employer Benefit Plans

By Sasha Bell

Offering competitive employee benefits is an important strategy for attracting and retaining talent. Many employer-sponsored benefit plans allow employees to pay for certain benefits on a pre-tax basis, which may provide tax advantages for both employees and employers. 

These tax advantages are subject to specific requirements under the Internal Revenue Code. Employers that sponsor certain pre-tax benefit plans must periodically evaluate whether their plans comply with applicable Non-Discrimination Testing (NDT) rules. These tests are designed to assess whether benefit plans operate in a manner that does not disproportionately favor certain groups of employees. 

This guide provides an overview of Non-Discrimination Testing, including what it is, which plans are affected, and key considerations for employers and HR professionals. 

Disclaimer: This content is for informational purposes only and does not constitute legal, tax, or financial advice. While we may reference applicable laws, it should not be relied upon as a substitute for professional guidance. Laws and regulations may change, and interpretations vary. Readers should consult their own legal or tax advisors for advice tailored to their specific situation. 

Table of Contents

What Is Non-Discrimination Testing? 

Non-Discrimination Testing refers to a set of IRS-mandated tests that vary by plan type and applicable IRS Code section and apply to certain employer-sponsored benefit plans offering pre-tax treatment. These tests are used to evaluate whether a plan’s eligibility, contributions, and benefits are available on a nondiscriminatory basis. 

Testing requirements arise under several sections of the Internal Revenue Code, including: 

The purpose of these rules is to prevent benefit plans from primarily benefiting highly compensated employees, key employees, or owners while still providing tax-favored treatment. 

Why Non-Discrimination Testing Is Important for Employers 

Non-Discrimination Testing plays a key role in  supporting the intended tax treatment of certain benefits. When required tests are not satisfied, the result is generally not plan disqualification, but rather unfavorable tax consequences for affected individuals. 

Potential impacts may include loss of pre-tax treatment for certain highly compensated or key employees, additional payroll and tax reporting obligations, and/or increased administrative complexity. 

In addition to tax considerations, regular testing supports benefit equity and transparency, which can contribute to employee confidence in benefit programs. 

Core Areas Evaluated in Non-Discrimination Testing

While testing methodologies vary by plan type, most Non-Discrimination Testing evaluates two fundamental areas: 

1. Eligibility and Participation 

Eligibility tests analyze who is allowed to participate in a benefit plan.  Plans are generally expected to be structured so that eligibility criteria do not disproportionately exclude non‑highly compensated employees. 

2. Contributions, Benefits, and Utilization 

These tests assess whether benefit levels, employer contributions, or benefit usage patterns favor specific employee groups. In some cases, even uniform plan designs can produce unfavorable results due to differing participation or utilization patterns. 

Common Non-Discrimination Tests by Plan Type

Section 125 Cafeteria Plan Testing

Cafeteria plans that allow pre-tax elections for benefits such as medical, dental, and vision coverage are generally subject to Section 125 testing. Common components may include: 

  • Eligibility testing 
  • Key employee concentration testing
  • Contributions and benefits testing

      Each test focuses on a different aspect of plan operation and relies on accurate employee classification. 

      Health Flexible Spending Accounts (Section 105(h))

      Health Flexible Spending Accounts (FSA) are generally treated as self-funded health plans and are subject to Section 105(h) non-discrimination rules. These rules evaluate whether the plan discriminates in favor of highly compensated individuals. 

      It is important to note that the definition of “highly compensated individual” under Section 105(h) differs from other sections of the Code and may include the top-paid portion of the workforce based on compensation levels. 

      Dependent Care Assistance Programs (Section 129)

      Dependent Care FSAs are subject to a series of tests under Section 129, which may include: 

      • Eligibility tests 
      • Contributions and benefits tests
      • Ownership concentration tests 
      • The 55% Average Benefits Test 

            Because dependent care benefits may be utilized more heavily by higher earners in some workforces, these plans require careful monitoring throughout the plan year. 

            Data Preparation and Employee Classification

            If certain testing elections, such as limiting highly compensated employees to the top-paid group, are used where permitted, they must be applied consistently and in accordance with plan rules. 

            Accurate data is essential for reliable testing results. Employers typically need employee compensation data, ownership and officer status information, participation and election records, and identification of highly compensated and key employees based on applicable thresholds. 

            Timing Considerations for Non-Discrimination Testing

            While many tests are finalized after the plan year ends, employers often perform preliminary reviews earlier in the year to identify potential issues. Common checkpoints include:

            • Early or pre-year testing to evaluate plan design 
            • Mid-year reviews following significant workforce changes
            • End-of-year testing based on final data  

                Early visibility can help employers evaluate available adjustment options before plan-year close.

                What Happens If a Plan Does Not Pass Testing?

                If a plan does not satisfy applicable Non-Discrimination Testing, the plan generally remains in place; many non-highly compensated employees are typically unaffected, and certain benefits may become taxable to affected individuals. Corrective actions vary by plan type and situation and may involve payroll adjustments or revised tax reporting. 

                Managing Ongoing Benefit Plan Compliance 

                Many employers use HR and benefits technology platforms to support accurate data tracking and assist with compliance monitoring efforts. Regular reviews, consistent classifications, and proactive testing can help reduce administrative burden and minimize unexpected outcomes. 

                For employers seeking a more detailed explanation of testing mechanics and compliance strategies, please email Navia at [email protected].  

                Access our Non-Discrimination Testing webinar for a deeper look at plan testing considerations and best practices

                FAQs

                Q1. What is Non-Discrimination Testing (NDT) for employer benefit plans?

                Non-Discrimination Testing refers to a specific set of IRS-mandated tests for pre-tax benefit programs. These tests verify that your company’s benefits do not unfairly favor highly compensated individuals, owners, or key employees over the rest of your workforce.

                Q2. Why do employer benefit plans need Non-Discrimination Testing?

                NDT is necessary to maintain eligibility for the tax-advantaged status of your benefit offerings and ensure ongoing IRS compliance. Passing these tests generally supports continued access to pre-tax treatment while also promoting fairness and transparency in your workplace benefits.

                Q3. Which types of employer benefit plans require IRS compliance testing?

                The most common plans that require testing include Section 125 Cafeteria plans (which handle medical, dental, and vision premiums), Section 105(h) self-funded health plans like Health FSAs, and Section 129 Dependent Care Assistance Programs.

                Q4. Who is considered a “highly compensated employee” during testing?

                The exact definition changes depending on the specific IRS code section you are testing. Generally, this group includes company officers, significant business owners, and employees earning above a specific compensation threshold set annually by the IRS.

                Q5. Are Health FSAs and Dependent Care FSAs tested the same way?

                No, they follow different rules. Health FSAs follow Section 105(h) guidelines, while Dependent Care FSAs fall under Section 129. Dependent Care plans often require careful monitoring throughout the year due to specific hurdles like the 55% Average Benefits Test.

                Navia and our staff’s suggestions or recommendations shall not constitute legal advice. No content on our website can be construed as tax or legal advice, and Navia may not be considered your legal counsel or tax advisor. Clients are encouraged to consult with their tax advisor and/or attorney to determine their legal rights, responsibilities, and liabilities. This includes the interpretation of any statute or regulation, federal, state, or local; and/or its application to the clients’ business activities.