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Key employee concentration testing

There are several tests that make up non-discrimination testing for Health FSAs and Dependent Care FSAs, but based on how Gusto offers these benefits, we focus on two of them currently: the key employee concentration test and the average benefits test.

The key employee concentration test requires that, of your employees’ total annual benefit amount, 25% or less of this amount comes from your key employees. The total annual benefit amount includes pre-tax premiums of all lines of coverage, such as medical, dental, and vision, for both employees and dependents. If none of your company’s key employees opt in to the Health FSA, your company passes this test automatically.

If key employees account for greater than 25% of the total annual benefit amount, you are said to be failing the key employee concentration test.

A key employee, as defined by the IRS, is identified as:

  1. An officer having an annual pay of more than $175,000, OR

  2. An employee or officer who for the length of the policy year is either of the following:

    • A 5% or greater owner of the business

    • A 1%-4.99% owner of the business whose annual pay is more than $150,000.

Questions & Answers

Q: What happens if we fail the key employee concentration test?

A: If we see that your company is failing this test during Open Enrollment, we will advise you to adjust your elections. This adjustment can happen in one of two ways:

  1. The key employees can lower their total benefit amount so that it is less than 25% of their company’s total benefit amount. This may be possible if the key employees lower their FSA elections, choose less expensive plans, opt out of certain coverages, or remove dependents from coverages.

  2. The key employees can choose not to participate in the FSA.

If we see that your company is failing this test toward the end of the plan year, we will advise you to retroactively treat your current year’s FSA elections as post-tax instead of pre-tax. This means key employees would pay taxes on their FSA elections, and the employer would be responsible for any related payroll taxes.

Q: My company only has a few employees, and we all own greater than 5% of the company. Can we offer a Health FSA and/or Dependent Care FSA?

A: Technically, it would not be compliant to offer a Health FSA and/or Dependent Care FSA in this situation because these tax advantages were built to benefit average employees at a company, not to give advantages to key employees or owners. A Health FSA and/or Dependent Care FSA may not be the right option for your group.