Glossary term
Section 105(h) Test
The Section 105(h) test is a nondiscrimination test for self-insured medical reimbursement plans that limits tax-favored benefits that favor highly compensated individuals.
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What Is the Section 105(h) Test?
The Section 105(h) test is a nondiscrimination test for self-insured medical reimbursement plans. It is designed to prevent those plans from giving tax-favored medical reimbursement benefits disproportionately to highly compensated individuals.
The rule is technical and applies to specific employer health arrangements. It is most often relevant for self-funded medical reimbursement plans, health reimbursement arrangements, and executive-focused reimbursement designs.
Key Takeaways
- Section 105(h) applies to self-insured medical reimbursement plans.
- The test looks at both eligibility and benefits.
- Plans cannot discriminate in favor of highly compensated individuals.
- If a self-insured plan fails, affected highly compensated individuals may lose tax-free treatment on excess reimbursements.
- The rules are separate from retirement-plan nondiscrimination testing and use their own definitions.
How the Test Works
Section 105(h) generally asks whether the plan discriminates in favor of highly compensated individuals in eligibility or benefits. Eligibility testing examines who can participate. Benefits testing examines whether the benefits available to highly compensated individuals are richer than those available to other employees.
A plan can fail because too few non-highly compensated employees are eligible, because benefits are not offered on nondiscriminatory terms, or because the plan design favors owners or executives.
Section 105(h) Testing Areas
Area | Question | Potential Consequence |
|---|---|---|
Eligibility | Who is allowed to participate? | Plan may favor highly compensated individuals |
Benefits | Are benefits available on equal terms? | Richer executive benefits may create failure |
Tax treatment | Are reimbursements excludable? | Excess reimbursements may become taxable to HCIs |
Plan design | Is the arrangement self-insured? | Determines whether Section 105(h) applies |
Employer Planning Context
Section 105(h) matters because the penalty is not usually loss of the plan for everyone. Instead, highly compensated individuals may have taxable income for excess reimbursements that otherwise would have been excluded. That makes testing important before reimbursements are paid, not only at year-end.
Employers should coordinate plan design, eligibility classes, reimbursement limits, and payroll reporting with benefits counsel or tax advisers. This glossary entry is educational and does not determine whether a specific plan passes.
The Bottom Line
The Section 105(h) test is a nondiscrimination rule for self-insured medical reimbursement plans. It protects the tax-favored treatment of benefits by requiring that the plan not favor highly compensated individuals in eligibility or benefits.