§105(h) Nondiscrimination Rules for Specialty HRAs

**Question: **What nondiscrimination rules apply to a specialty HRA (such as an infertility HRA) that an employer would like to make available on different terms to different employee classes?

An HRA is a self-insured group health plan, and therefore it is subject to the §105(h) nondiscrimination rules.  This includes specialty HRAs such as infertility HRAs, autism HRAs, mental health HRAs, transgender reassignment surgery HRAs, etc.

For more information on specialty HRAs, see our previous posts addressing infertility HRAs:

105(h) Overview

The §105(h) nondiscrimination rules are designed to prevent discrimination in self-funded health plan design in favor of highly compensated individuals (HCIs). The §105(h) rules define HCIs differently from the §125 cafeteria plan HCP definition.

For purposes of §105(h), an HCI is:

  • One of the top five highest-paid officers;

  • A shareholder who owns more than 10% of the value of stock; or

  • Among the highest-paid 25% of all employees.

There are three main components of the §105(h) non-discrimination rules:

  • Eligibility Test

  • Benefits Test

  • Operational Discrimination Test

Each are addressed in turn below.

1. 105(h) Nondiscrimination: Eligibility Test

For purposes of eligibility, a self-funded plan can exclude or provide different eligibility terms for categories of employees only if the classification is reasonable and nondiscriminatory.

The definition of “reasonable and nondiscriminatory” specifically refers to distinctions based on the nature of compensation, such as hourly vs. salaried, and geographic location.

Therefore, it will not be an issue for the employer to provide different specialty HRA eligibility terms to employees based on hourly vs. salaried or employee groups in different regions.

** 2. 105(h) Nondiscrimination: Benefits Test**

The benefits test component requires that all benefits provided to eligible HCIs under the plan also be available to all eligible non-HCIs.

Under a single plan testing approach, creating different classes of benefits for eligible employees would be a problem because it would result in non-HCIs in the lower tier benefit class not receiving the richer benefits available to HCIs in the higher class.

For example, take an employer that designs a specialty HRA with a $15,000 annual limit for Class A, and a $10,000 annual limit for Class B.  This would be a problem under a single plan testing approach because the plan would not provide non-HCIs in Class B the same benefits as those available to HCIs in Class A.

However, the §105(h) rules allow employers to disaggregate the plan into two separate plans for nondiscrimination testing purposes. Therefore, employers can specify in the HRA plan document that the different benefit arrangements are to be considered separate plans—even if they are included in a single plan document. That will permit each group to separately pass the Benefits Test.

Here is a template HRA plan document provision for this purpose:

Section 105(h): Separate Plans

Pursuant to the “Multiple plans” provisions set forth in Treas. Reg. §1.105-11(c)(4), each coverage level, each group of Employees covered by the Plan, and each class of benefits provided under the Plan constitute a separate “plan” for purposes of the Internal Revenue Code Section 105(h) nondiscrimination requirements and any other applicable law.

3. 105(h) Nondiscrimination: Operational Discrimination

Finally, the §105(h) rules include an umbrella provision preventing self-insured health plans from discriminating against HCIs in operation.  Whether a plan is operationally discriminatory is a facts and circumstances test based on each plan’s specific arrangement.

The limited guidance available for this rule suggests it would rarely become an issue in specialty HRA plan design.  For example, a plan is not considered discriminatory merely because HCIs participating in the plan utilize plan benefits to a greater extent than non-HCIs.

The IRS’s main concern with this requirement appears to be that the employer does not selectively establish, amend, or terminate the plan in a manner designed to benefit HCIs.  For example, an employer would act in a manner that is operationally discriminatory if it established or improved an infertility HRA to cover a HCI’s infertility expenses, then reduced or terminated the HRA upon a non-HCI expressing interest in the same benefits.

Failing the Section 105(h) Nondiscrimination Requirements

If the IRS were to audit a specialty HRA and find its arrangement to be discriminatory under §105(h), all HCIs would be taxed on all or a portion of the benefits they received under the plan, referred to as the “excess reimbursement.” This could be a significant tax liability depending on the amount and cost of services actually received by the HCIs.


Internal Revenue Code §105(h)(5):

(5) Highly compensated individual defined.

For purposes of this subsection, the term “highly compensated individual” means an individual who is—

(A)  one of the 5 highest paid officers,

(B)  a shareholder who owns (with the application of section 318 ) more than 10 percent in value of the stock of the employer, or

(C)  among the highest paid 25 percent of all employees (other than employees described in paragraph (3)(B) who are not participants).

Treas. Reg. §1.105-11(c)(2)(iii):

(ii) Classification test. A plan satisfies the requirements of this subparagraph if it benefits such employees as qualify under a classification of employees set up by the employer which is found by the Internal Revenue Service not to be discriminatory in favor of highly compensated individuals. In general, this determination will be made based upon the facts and circumstances of each case, applying the same standards as are applied under section 410(b)(1)(B) (relating to qualified pension, profit-sharing and stock bonus plans), without regard to the special rules in section 401(a)(5) concerning eligibility to participate.

Treas. Reg. §1.410(b)-4(b):

(b) Reasonable classification established by the employer. A classification is established by the employer in accordance with this paragraph (b) if and only if, based on all the facts and circumstances, the classification is reasonable and is established under objective business criteria that identify the category of employees who benefit under the plan. Reasonable classifications generally include specified job categories, nature of compensation (i.e., salaried or hourly), geographic location, and similar bona fide business criteria. An enumeration of employees by name or other specific criteria having substantially the same effect as an enumeration by name is not considered a reasonable classification.

Treas. Reg. §1.105-11(c)(3)(i):

(3) Nondiscriminatory benefits.

(i) In general. In general, benefits subject to reimbursement under a plan must not discriminate in favor of highly compensated individuals. Plan benefits will not satisfy the requirements of this subparagraph unless all the benefits provided for participants who are highly compensated individuals are provided for all other participants…

Treas. Reg. §1.105-11(c)(4)(i):

(4) 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) 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.

IRS Chief Counsel Memorandum FREV-113006-01:

Section 1.105-11(c)(4) of the regulations provides that, “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 plan.” Thus, if each of the plans is tested as two separate plans (one for the surviving spouse and dependents of physicians and another plan for everyone else), each plan will pass the benefits test.

Treas. Reg. §1.105-11(c)(3)(ii):

(ii) Discriminatory operation. Not only must a plan not discriminate on its face in providing benefits in favor of highly compensated individuals, the plan also must not discriminate in favor of such employees in actual operation. The determination of whether plan benefits discriminate in operation in favor of highly compensated individuals is made on the basis of the facts and circumstances of each case. A plan is not considered discriminatory merely because highly compensated individuals participating in the plan utilize a broad range of plan benefits to a greater extent than do other employees participating in the plan. In addition, if a plan (or a particular benefit provided by a plan) is terminated, the termination would cause the plan benefits to be discriminatory if the duration of the plan (or benefit) has the effect of discriminating in favor of highly compensated individuals. Accordingly, the prohibited discrimination may occur where the duration of a particular benefit coincides with the period during which a highly compensated individual utilizes the benefit.

Treas. Reg. §1.105-11(e)(1):

(e) Excess reimbursement of highly compensated individual.

(1) In general. For purposes of section 105(h) and this section, a reimbursement paid to a highly compensated individual is an excess reimbursement if it is paid pursuant to a plan that fails to satisfy the requirements of paragraph (c)(2) or (c)(3) for the plan year. The amount reimbursed to a highly compensated individual which constitutes an excess reimbursement is not excludable from such individual’s gross income under section 105(b).

Brian Gilmore
The Author
Brian Gilmore

Lead Benefits Counsel, VP, Newfront

Brian Gilmore is the Lead Benefits Counsel at Newfront. He assists clients on a wide variety of employee benefits compliance issues. The primary areas of his practice include ERISA, ACA, COBRA, HIPAA, Section 125 Cafeteria Plans, and 401(k) plans. Brian also presents regularly at trade events and in webinars on current hot topics in employee benefits law.

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