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What Should I Do if an Employee is Failing ‘Key Employee’ Test?

Written by Aimee Reynard
Updated 1 month ago

If your employee is failing the 'Key Employee' portion of the test, it means that the Key Employee participation makes up over 25% of the total pre-tax benefits usage, which the IRS would consider to be discriminatory.

The best ways to resolve a situation like this would be:

  1. Have key employees stop participating on a pre-tax basis. If all key employees stop pre-taxing then their participation amount drops to $0 which would mean they pass.  Also, depending on how many key employees are participating, having a few volunteer to stop pre-taxing could work.  If enough key employees volunteered to stop pre-taxing to drop the total key participation to under 25%, that would also be acceptable.
  2. Have the key employees stop pre-taxing certain benefits. For example, if medical, vision, and dental are all offered on a pre-tax basis, having key employees stop pre-taxing their contributions for one of those three benefits specifically may reduce the total key employee participation enough to drop to or below the 25%.

This may help provide some clarification for #2: When calculating the number for the Key Employee question on the test, any participation in the pre-tax for a specific benefit means that the entire premium for that benefit is included in the total. 

So let's say, for example, that an employee is in a medical, dental and vision plan and each plan has a $150 premium. If the employee is contributing $100 pre-tax and the employer is contributing $50, the total number for the sake of the testing will be $150 for each benefit, which would come to $450. 

(Please note: If the employee were to adjust their deductions to $50 pre tax and $50 post tax for each plan, and the employer is still contributing a further $50, the number for the sake of the testing will still be $150 for each benefit, so the total would still come to $450.)  

Now, if that employee decided to change their entire medical contribution to $100 post-tax (with the $50 from the employer still included), the number for their testing drops from $450 to $300 since one plan of $150 is no longer being pre-taxed.

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