Section 105: Health Plan Nondiscrimination Rules


Section 105(b) of the Internal Revenue Code generally excludes from gross income amounts paid through employer-sponsored health coverage. This exclusion may not apply to benefits provided to highly compensated individuals (“HCIs”) under a self-insured or level-funded) plan if the plan discriminates in favor of these individuals in terms of benefits or eligibility (as defined in Section 105(h)).

The ACA, Sec. 1001 as amended by Sec. 10101 (new Public Health Service Act Sec. 2716) amended the Internal Revenue Code to require non-grandfathered, insured group health plans to satisfy certain provisions of Section 105(h), including the prohibition against discrimination in favor highly-compensated employees with respect to plan eligibility and benefits, for plan years beginning on or after September 23, 2010. Prior to the enactment of the ACA, insured group health plans were not subject to Section 105(h) requirements.

To determine if a self-insured or fully-insured health plan is discriminatory in favor of HCIs, plans must be tested under Section 105(h) criteria, including:

See Nondiscrimination Tests below:

Plans Covered

Employment-based health plans that are:

The nondiscrimination requirements do not apply to certain fully-insured benefit plans, including:

Note: Employers should also review severance plans under which a highly compensated individual is offered health coverage (often in the form of a COBRA subsidy) on a more favorable basis than for active employees, either in terms of a subsidized COBRA payment or in the duration of coverage. Employers may need to adjust these policies once the agencies issue further guidance.

Highly Compensated Individuals

For purposes of Section 105(h), an HCI is defined as an individual who meets at least one of the following criteria:

All employees meeting at least one of these criteria are included in the “prohibited group” for Section 105(h) testing purposes- which is the group that cannot benefit from more favorable eligibility terms or benefit provisions in a group health plan. These requirements are not mutually exclusive. The five highest paid officers may also be among the highest paid 25% of all employees. However, if one of the top five officers is not in that pay range, that officer still needs to be included in the prohibited group.

Nondiscrimination Tests

Eligibility Tests

The eligibility tests are designed to ensure that the employer-sponsored plan does not discriminate in favor of HCIs in terms of eligibility to participate in a group health plan. This means that eligibility to participate in the plan must be available to non-HCIs under terms at least as favorable as the eligibility terms for HCIs.

Three Alternative Tests

A plan will pass if it meets any one of the three tests:

  1. bona fide business classifications for any exclusions (a subjective component), and
  2. a sufficient ratio of benefiting non-HCIs to benefiting HCIs (an “objective”component)

Excludable Employees

Certain employees are “excludable” for purposes of Section 105(h), and therefore may be excluded from the eligibility tests, including:

Important Note: Each group is excludable from testing only if the group is not actually eligible to participate in the plan. In addition, nonexcludable employees of all employers sufficiently related to be in the same controlled group or affiliated service group (as defined under Internal Revenue Code Section 414) must be included when completing any of the three alternative eligibility tests.

Benefits Test

This test is designed to ensure that HCIs who elect to participate in the plan are not receiving better benefits under the plan than are provided to non-HCIs. A plan will pass the benefits test if:

  1. All benefits provided to highly compensated participants under the plan are provided to all other participants. Must be the same type and amount of benefit; and
  2. The plan does not discriminate in actual operation. This tests the benefits available to employees, not actual utilization of those benefits.


When Should the Section 105(h) Tests be Run?

A plan must satisfy the tests “for a plan year,” which is interpreted to require the plan to pass on each day of the year. Employers who believe their plan is in danger of passing must monitor their plan design and participation throughout the year so adjustments may be made to ensure that the tests are passed. This is especially important if significant changes to workforce occur, such as after a merger or acquisition.

In addition, be sure to test any new fully insured plans that do not get the benefit of the grandfathered plan exemption to Section 105(h) prior to implementation to ensure the plan will pass testing.

Important Note: This Compliance Activity contains general information about the nondiscrimination rules applicable to group health plans under the Internal Revenue Code. However, these rules are very complex and failure to comply can result in significant tax consequences to employers and employees. The advice of a qualified legal or tax professional is required to determine application of these rules to a particular employer and its group health plans.


Self-Insured (or Level-Funded) Plans

If a self-insured health plan discriminates in favor of HCIs, the affected HCIs must include some or all of the value of the benefits received in their taxable income. This imputed income is subject to federal income taxes (but not to Social Security or Medicare taxes), and potentially to state taxes as well.


The IRS has indicated that it will release additional guidance related to the application of Section 105(h) to fully-insured plans in the future, and this Compliance Activity will be updated when any such guidance is issued.

Fully Insured Plans*

If a fully insured plan discriminates in favor of HCIs, the plan sponsor will be required to pay an excise tax of $100 per day per individual discriminated against for each day the plan is not in compliance, pursuant to Section 4980D of the Internal Revenue Code. Such plans could also face civil action under ERISA or the Public Health Service Act.

*In a notice issued on December 22, 2010, the Treasury Department announced a delay in the enforcement of the Internal Revenue Code Section 105(h) nondiscrimination rules against fully-insured (non-grandfathered) group health plans under the Affordable Care Act (“ACA”). Notice 2011-1 recognizes that the ACA’s application of rules “similar to” the Section 105(h) rules, previously only applicable to self-insured group health plans, should not be enforced against fully-insured group health plans until the IRS issues specific guidance on how to comply with those rules.

Therefore, any sanctions for failure to comply will not apply until after regulations or other administrative guidance of general applicability has been issued. In order to provide insured group health plan sponsors time to implement any changes required as a result of the regulations or other guidance, the Department anticipates that the guidance will not apply until plan years beginning a specified period after issuance. Before the beginning of those plan years, an insured group health plan sponsor will not be required to file IRS Form 8928 with respect to excise taxes resulting from the incorporation of PHS Act Sec. 2716 into Sec. 9815 of the Code.

Additional Resources

Notice 2011-1 Delaying Enforcement for Fully Insured Plans

IRS Notice 2010-63

IRC Section 105(h)