Many employee benefits are excluded from employees’ gross income and, thus, are not taxable when specific conditions are met. One of these conditions is often some type of nondiscrimination requirement, which ensures that the benefit plan does not discriminate in favor of certain highly compensated or key employees. It is important to take the applicable nondiscrimination rules into account when structuring your employee benefit plans in order to maintain your plans’ tax advantage.

There is no universal set of nondiscrimination rules; they vary for each type of benefit. Key concepts that are often involved with nondiscrimination testing include:

The rest of this article discusses some of the types of benefits that must comply with nondiscrimination rules.

Self-funded health plans pass the Code § 105(h) nondiscrimination rules if the plan does not discriminate in favor of HCIs with respect to eligibility or benefits. If discrimination exists in favor of HCIs, the excess reimbursements received by those employees must be included in their gross income. In addition to self-funded health plans, 105(h) testing also applies to General Health and Limited Purpose Flexible Spending Accounts.

A cafeteria plan lets employees choose between receiving their regular pay or using that money to pay for certain benefits before taxes are taken out. Normally, if an employee has the option to take cash, the IRS treats that amount as taxable income, even if they choose benefits instead. But cafeteria plans are a special exception: employees aren’t taxed on the money they use for qualified benefits. However, this tax advantage only applies if the plan follows non-discrimination rules.  If a cafeteria plan discriminates in favor of HCIs or key employees, each member of the prohibited group will lose the cafeteria plan’s tax advantage.

For plan years starting in 2026, an employee can exclude up to $7,500 of dependent care benefits from their gross income (if single or married and filing a joint tax return), or up to $3,750 (if married but filing separate tax returns). The plan is considered nondiscriminatory if the program’s eligibility, contributions and benefits provided do not discriminate in favor of HCIs or certain shareholders or owners. If discrimination is found in a dependent care assistance program, these individuals must include dependent care benefits in their gross income.