Employers who sponsor qualified defined benefit (DB) and defined contribution (DC) plans are responsible for making sure that their plans remain in compliance with IRS requirements, as failure to do so can result in excessive costs, penalties, or even plan disqualification. These requirements include the nondiscrimination rules, which are complex and can cause problems for plan sponsors that are unfamiliar with the details. Part 1 of this series outlines the framework for the testing. Parts 2 and 3 will explain the basic requirements of the testing and describe common pitfalls to be avoided.
Part 1

What is nondiscrimination testing?

Certain benefit plans may be deemed qualified by the IRS and therefore eligible for favorable tax treatment, as long as they do not provide excessive benefits to upper management at the expense of the lower-paid employees. The nondiscrimination rules were established to give plan sponsors a framework for demonstrating that their plans do not provide benefits that discriminate in favor of the highly compensated employees (HCEs).

HCEs are generally those employees with total compensation in excess of a specified limit. For example, if an employee earns more than $110,000 in 2011, the employee would be considered to be an HCE in 2012. (There is an alternative top 20% definition that applies for some plans.) Employees who own more than 5% of the organization are also considered to be HCEs. The remainder of the employees would be non-highly compensated employees (NHCEs).

Who are the employees?

Before this question can be answered, a plan sponsor must first determine if its organization is part of a controlled group. In general, two organizations are considered part of a controlled group if one organization owns at least 80% of the other, or are connected through a common parent that owns 80% of each organization. (Other types of controlled groups are also possible.) When performing the nondiscrimination testing, all employees of the controlled group must be considered.

Certain employees can be excluded for testing purposes, such as:

• Collectively bargained employees


• Non-U.S. residents with no U.S. source income


• Employees who do not meet certain criteria (for example, age 21 with at least one year of service)

What plans need to be tested?

Plan sponsors need to identify which plans need to be tested. Some plans can be aggregated (or separated) for testing purposes. For example, one plan that benefits executives could be aggregated with a second plan that benefits the rank-and-file employees, if the plans meet certain requirements.

Some plans are exempt from the testing. These include plans that benefit only NHCEs and/or collectively bargained employees, or frozen plans that have ceased providing additional accruals or contributions.