When Is FSA Non-Discrimination Testing Due?

Flexible Spending Accounts (FSAs) offer employees a way to pay for certain healthcare or dependent care expenses with pre-tax dollars. This tax advantage benefits both employees and employers. To maintain their tax-favored status, these plans must adhere to Internal Revenue Service (IRS) regulations, including non-discrimination requirements. These rules are in place to ensure that FSA plans do not disproportionately favor highly compensated employees over other employees, promoting fairness and compliance across the workforce.

Annual Testing Requirements and Deadlines

While there is no fixed due date for Flexible Spending Account non-discrimination testing, it is an annual requirement for the preceding plan year. This testing ensures ongoing compliance with Internal Revenue Code Section 125, which governs cafeteria plans under which most FSAs are offered. The purpose is to verify that the plan did not discriminate in favor of highly compensated or key employees during the plan year.

Employers perform this testing at the end of the plan year or shortly thereafter. For instance, testing for a calendar year plan should be completed by December 31st. Conducting testing early, perhaps mid-year, allows employers to identify potential issues and make necessary adjustments before the plan year concludes. This proactive approach helps avoid adverse tax consequences for highly compensated individuals.

Key Non-Discrimination Tests for FSAs

Flexible Spending Accounts are subject to non-discrimination tests. An HCE is generally defined as an employee who earned above a certain compensation threshold in the prior year (e.g., $160,000 for 2025 testing), or who owns more than 5% of the company. For health FSAs, a highly compensated individual (HCI) can also be one of the top five highest-paid officers or among the top 25% compensated employees.

The Eligibility Test examines whether a sufficient number of non-highly compensated employees are eligible to participate in the plan. This test ensures that the plan is available to a broad group of employees, not just a select few. For health FSAs, this might involve checking if 70% or more of all employees benefit from the plan, or if a nondiscriminatory classification test is met.

The Benefits Test focuses on whether the benefits provided, such as maximum election amounts, are uniform for all participants. This test ensures that the plan’s terms and operations do not favor highly compensated individuals. For instance, the maximum benefit level cannot vary based on compensation, age, or years of service.

The Contributions and Benefits Test, also known as the 25% Concentration Test, ensures that key employees do not receive more than 25% of the total non-taxable benefits provided under the FSA plan. For dependent care FSAs, a 55% Average Benefits Test is also applied, requiring the average benefit for non-HCEs to be at least 55% of the average benefit for HCEs.

Data Collection and Test Execution

Performing Flexible Spending Account non-discrimination tests requires data collection. Employers need employee census data, which includes names, compensation, hire dates, employment status, and an accurate designation of highly compensated employee (HCE) or key employee status for each individual.

Beyond demographic data, the testing process also requires financial details related to the FSA plan. This includes the FSA election amounts for all participating employees and the actual FSA reimbursements paid out to all participants during the plan year.

Employers gather this data from various internal systems, such as payroll records and benefit administration platforms. Once collected, the data is applied to the test calculations, such as determining the proportion of benefits received by HCEs versus non-HCEs or calculating average benefit utilization.

Addressing Test Failures

If a Flexible Spending Account non-discrimination test reveals a failure, correction involves adjusting the benefits for highly compensated employees (HCEs). Excess contributions received by HCEs become taxable income for them.

For health FSAs, the amounts considered “excess reimbursements” become taxable to the HCEs. For dependent care FSAs, if the 55% Average Benefits Test fails, HCEs’ pre-tax contributions may need to be reduced to a passing level.

These corrective actions must be completed by the end of the plan year to maintain the tax-favored status for HCEs. For calendar year plans, this means corrections should be finalized by December 31st. Failure to correct in a timely manner means that the HCEs’ FSA benefits, or the portion deemed discriminatory, will be included in their gross income for tax purposes.