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Average benefits 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 average benefits test applies only to Dependent Care FSAs. This test requires that the average election amount for the Dependent Care FSA of non-highly compensated employees be at least 55% of the average election amount for the Dependent Care FSA of highly compensated employees.

It can be difficult to predict whether your company may pass or fail this test until Open Enrollment is over, as it is based solely on your employees’ choice to opt into (or out of) the Dependent Care FSA.

A highly compensated employee, as defined by the IRS, is identified as an employee:

  1. Who owns more than 5% of the outstanding stock or total voting power of a corporation or 5% of capital profits interest if not a corporation at any time during the policy year, OR

  2. For the preceding year, received >$120,000 in compensation OR

  3. For the preceding year, was among the top 20% of employees in terms of compensation paid

Employees who satisfy the following criteria do not count toward the top-paid group:

  1. Have not completed 6 months of service or

  2. Normally work less than 17.5 hours per week or

  3. Normally work not more than 6 months during any year or

  4. Are under 21 years of age

Questions & Answers

Q: What happens if we fail the average benefits test?

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

  1. The highly compensated employee(s) can lower their elections to an amount that satisfies the restraints of the test or remove their elections altogether.

  2. The company can garner interest from other non-highly compensated employees, and if any of them choose to opt-in at an amount that satisfies the restraints of the test, the company could then pass.

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

Q: Everyone in my company makes over $120,000. Can we offer a Dependent Care FSA?

A: Technically, it would not be compliant to offer a Dependent Care FSA in this situation. The Dependent Care FSA may not be the right option for your group.

Q: My company only has a few employees, and we all own greater than 5% of the company. Can we offer an 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. A Health FSA and/or Dependent Care FSA may not be the right option for your group.