Question: What are the nondiscrimination rules that apply for HSA contributions?

Compliance Team Response:  

Employer HSA contributions are subject to one of two sets of nondiscrimination rules:

1. The comparability rules of IRC §4980G; or

2. The cafeteria plan nondiscrimination rules for IRC §125.

The comparability rules are very strict and difficult to pass.  It is also difficult to find an administrator that can run this form of testing for an employer.

Virtually all employer HSA contributions are instead subject to the §125 cafeteria plan nondiscrimination rules (rather than the comparability rules).  This is because almost all employers permit employees to make pre-tax HSA contributions through the cafeteria plan.

The HSA comparability rules do not apply to employer contributions made through a cafeteria plan. The comparability regulations, cafeteria plan regulations, and other IRS guidance all make clear that employer contributions to an employee’s HSA are made “through a cafeteria plan” where employees may contribute to the HSA on a pre-tax basis through the cafeteria plan by salary reduction.

Therefore, where employees of the company are permitted to contribute to an HSA on a pre-tax basis through the company’s cafeteria plan, the company’s contributions are not subject to the comparability rules.

Failure to permit employees to contribute to their HSA on a pre-tax basis creates potential excise tax liability under the comparability rules set forth in Treas. Reg. §54.4980G-1 et. seq.  That penalty amount would be 35% of the company’s total HSA contributions.

We therefore always recommend that employers permit employee pre-tax HSA contributions through payroll to a) avoid potential comparability testing excise tax liability, and b) have HSA contributions instead be subject to the relatively easy-to-pass §125 cafeteria plan nondiscrimination rules.

Regulations:

Treas. Reg. §54.4980G-5, Q/A-1:

Q-1. If an employer makes contributions through a section 125 cafeteria plan to the HSA of each employee who is an eligible individual, are the contributions subject to the comparability rules?

A-1. (a) In general. No. The comparability rules do not apply to HSA contributions that an employer makes through a section 125 cafeteria plan. However, contributions to an HSA made through a cafeteria plan are subject to the section 125 nondiscrimination rules (eligibility rules, contributions and benefits tests and key employee concentration tests). See section 125(b), (c) and (g) and the regulations thereunder.

(b) Contributions made through a section 125 cafeteria plan. Employer contributions to employees’ HSAs are made through a section 125 cafeteria plan and are subject to the section 125 cafeteria plan nondiscrimination rules and not the comparability rules if under the written cafeteria plan, the employees have the right to elect to receive cash or other taxable benefits in lieu of all or a portion of an HSA contribution (meaning that all or a portion of the HSA contributions are available as pre-tax salary reduction amounts), regardless of whether an employee actually elects to contribute any amount to the HSA by salary reduction.

IRS Notice 2004-50, Q/A-47:

https://www.irs.gov/irb/2004-33_IRB#NOT-2004-50

Q-47. If an employer makes contributions through a cafeteria plan to the HSA of each employee who is an eligible individual in an amount equal to the amount of the employee’s HSA contribution or a percentage of the amount of the employee’s HSA contribution (i.e., “matching contributions”), are the contributions subject to the section 4980G comparability rules?

A-47. No. The conference report for the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 states that the comparability rules do not apply to contributions made through a cafeteria plan. Conf. Rep. No. 391, 108th Cong., 1st Sess. 840 (2003). Notice 2004-2, Q&A 32 similarly provides that the comparability rules do not apply to HSA contributions made through a cafeteria plan. Thus, where matching contributions are made by an employer through a cafeteria plan, the contributions are not subject to the comparability rules of section 4980G. However, contributions, including “matching contributions”, to an HSA made under a cafeteria plan are subject to the section 125 nondiscrimination rules (eligibility rules, contributions and benefits tests and key employee concentration tests). See ,section 125(b), (c) and (g) and Prop. Treas. Reg. § 1.125-1, Q&A 19.

Prop. Treas. Reg. §1.125-7(n):

(n) Employer contributions to employees’ Health Savings Accounts. If an employer contributes to employees’ Health Savings Accounts (HSAs) through a cafeteria plan (as defined in §54.4980G-5 of this chapter) those contributions are subject to the nondiscrimination rules in section 125 and this section and are not subject to the comparability rules in section 4980G. See §§54.4980G-0 through 54.4980G-5 of this chapter.

Treas. Reg. §54.4980G-1, Q/A-4:

Q-4.  How is the excise tax computed if employer contributions do not satisfy the comparability rules for a calendar year?

A-4. (a) Computation of tax. If employer contributions do not satisfy the comparability rules for a calendar year, the employer is subject to an excise tax equal to 35% of the aggregate amount contributed by the employer to HSAs for that period.

(b) Example. The following example illustrates the rules in paragraph (a) of this Q&A-4:

Example. During the 2007 calendar year, Employer D has 8 employees who are eligible individuals with self-only coverage under an HDHP provided by Employer D. The deductible for the HDHP is $2,000. For the 2007 calendar year, Employer D contributes $2,000 each to the HSAs of two employees and $1,000 each to the HSAs of the other six employees, for total HSA contributions of $10,000. Employer D’s contributions do not satisfy the comparability rules. Therefore, Employer D is subject to an excise tax of $3,500 (35% of $10,000) for its failure to make comparable contributions to its employees’ HSAs.