* If you choose to run additional tests to identify any discriminatory excess, your highly compensated employees will be taxed instead on that cost. Again, you can elect to raise their compensation to cover the additional taxes. Your choice between this option and the preceding one will depend on your estimate of the cost of the testing, weighed against the cost to your employees of the tax hike -- and to you if you decide to cover that expense. Obviously, the tax on the discriminatory excess will be smaller than that on the entire benefit.
* You can change your benefit plans to eliminate the discriminatory excess either by extending coverage to your non-highly compensated employees or by reducing the coverage of your highly compensated employees.
* You can make no effort to comply and tell employees they're on their own so far as taxes are concerned.
* Finally, you can eliminate your benefit plans entirely.
As you can see, Section 89 is complex -- witness the number of workshops, handbooks, and the like that benefit specialists have put together. Your strategy for dealing with the law will depend on your company's particular circumstances and, ultimately, on what you want your benefit plans to accomplish.
JUST WHAT IS AN HCE?
To comply with Section 89, you have to identify your highly compensated employees
According to the IRS, an HCE is:
* Any employee who owns 5% or more of your company.
* Any employee who earns more than $50,000 annually and is in the company's top 20% in compensation.
* Any employee who is an officer of your company and earns more than $45,000 per year. No fewer than one and no more than 50 officers may be included.
TESTING, TESTING
Determining whether your plan continues to qualify for tax-free benefits under Section 89 involves several steps
The IRS asks you to measure both who is eligible to receive benefits and whether the benefits are reasonably comparable in order to exempt them from employees' income tax. If you don't qualify under the 80% test described in the text, here are the additional tests:
* At least 50% of employees eligible to participate in a plan must be non-highly compensated. Say you have 10 people in your company, and all receive benefits. If 6 of those meet the IRS definition of highly compensated employees, you would fail the test, because only 40% of those eligible are non-highly compensated. But there's another test you can try. The percentage of non-highly compensated employees eligible to participate must be at least equal to the percentage of highly compensated employees eligible. So, in our example, if everyone in your 10-person company was eligible to participate, you would pass, since 100% of both non-highly compensated and highly compensated employees receive benefits.
* At least 90% of non-highly compensated employees must be eligible for benefits worth 50% or more of what the most highly compensated employees get. For example, an entry-level secretary must be eligible for a benefit worth at least half what the chief executive officer could get.
* A plan can't contain any provision that, by its terms or effects, discriminates in favor of highly compensated employees. For example, the IRS may rule that a plan is discriminatory if it's designed to meet the unusual needs of a few highly compensated employees -- covering a particularly disability, say -- even though the benefits are theoretically available to all.
* What benefits does your plan actually deliver? The new law specifies a test here, too. The average value of benefits for all non-highly compensated employees must be at least 75% of the average value of benefits for highly compensated employees.
* Benefits of employees who terminate after January 1, 1989, must be counted. Benefits to employees who left the company before then need not be counted in the tests -- unless they are rehired after January 1 or the benefits are modified.
HOW TO CALCULATE THE VALUE OF YOUR EMPLOYEE BENEFITS
For now, at least, the procedure is anything but simple
Both the eligibility and benefits tests require that you place a value on the benefits you provide, and the IRS is developing procedures for valuation. In the meantime, here's what you should do:
* Life insurance. Special, complex tests are required for life insurance to which employees contribute. Are you sitting down for this one?
You determine the value of the benefit you provide as a percentage of the employee's compensation. To do that, divide your contribution by your employee's contribution. Then multiply this ratio by the face value of the coverage. Divide the resulting dollar figure by your employee's compensation. Next, find the appropriate value for the resulting percentage in an IRS tax table, and multiply the two figures to calculate a hypothetical standardized annual premium.
It's these IRS-adjusted premiums that are compared to your plan's premiums to determine whether the plan is discriminatory. Group term life insurance won't be treated as discriminatory if the amount of coverage employees receive is an equal percentage of their compensation across the board. For instance, if all eligible employees are covered by life insurance equal to four times their salaries, the law says there is no discrimination.
* Health-care plans. The Treasury hasn't yet come up with workable standard tables of value for health-care plans. So for now, employers can use their actual cost or any other actuarially reasonable method. If you use your actual costs to value the benefits your employees receive, you can make reasonable adjustments to compensate for differences in your costs that are due to location, demographics, or how different employee groups use plans that offer the same benefits. Whatever method you choose, you must use the same one for all your health-care plans and keep good records for IRS audits.
