8799 / What are the tax consequences for amounts paid by an employer to highly compensated employees under a discriminatory self-insured medical expense reimbursement plan?

If a self-insured medical reimbursement plan is found to be discriminatory in favor of highly compensated employees, those highly compensated employees may be taxed on reimbursed amounts provided under the plan. The taxable amount of payments is the “excess reimbursement.”¹ The two situations discussed below will produce an excess reimbursement.

The first situation occurs when a benefit is available to a highly compensated individual but not to all other participants, or if the benefit otherwise discriminates in favor of highly compensated individuals. In this case, the total amount reimbursed under the plan to the employee with respect to that benefit is an excess reimbursement.

The second situation occurs when a plan discriminates as to participation, even though all benefits are available to all other participants and are not otherwise discriminatory. If this is the case, the excess reimbursement is determined by multiplying the total amount reimbursed to the highly compensated individual for the plan year by a fraction. The numerator of this fraction is the total amount reimbursed to all participants who are highly compensated individuals under the plan for the plan year and the denominator is the total amount reimbursed to all employees under the plan for such plan year. In determining the fraction, any reimbursement attributable to a benefit not available to all other participants is not taken into account.²

Multiple plans may be designated as a single plan for purposes of satisfying nondiscrimination requirements. If an employee elects to participate in an optional HMO offered by the plan, that employee is considered benefited by the plan only if the employer’s contributions with respect to the employee are at least equal to what would have been made to the self-insured plan and the HMO is designated, with the self-insured plan, as a single plan.

Unless a plan provides otherwise, reimbursements will be attributed to the plan year in which payment is made. Accordingly, they will be subject to tax in an individual’s tax year in which a plan year ends.

Amounts reimbursed for medical diagnostic procedures for employees, but not dependents, performed at a facility that provides only medical services are not considered a part of a plan and do not come within these rules requiring nondiscriminatory treatment.³