HSA Non-Discrimination Testing: Cafeteria Plan and Comparability Rules

HSA non-discrimination testing splits into two completely separate regimes, and which one applies to you depends on a single structural choice: whether your employer HSA contributions run through a Section 125 cafeteria plan or go directly into employees’ HSAs. Cafeteria plan contributions get tested under the three Section 125 non-discrimination tests. Direct contributions get tested under the comparability rules of Section 4980G. The two frameworks do not overlap, they measure different things, and they punish failure in very different ways.¹

Mixing them up is one of the more expensive mistakes in benefits administration, so the first job is knowing which lane you’re in.

Which Rules Apply to Your Contributions

If employees can choose between taxable wages and a pre-tax HSA contribution, or if the employer routes its own HSA contributions through the cafeteria plan alongside other pre-tax benefits, the contributions are cafeteria plan contributions. The comparability rules do not apply at all in that case.¹

If the employer simply deposits money into employee HSAs outside any cafeteria plan structure, the comparability rules under Section 4980G apply instead.² You’re in one lane or the other.

Who Counts as Highly Compensated or Key

Running the Section 125 tests requires classifying every employee first. The comparability rules don’t use these categories, but anyone operating a cafeteria plan needs them.

Highly Compensated Employees

For the 2026 plan year, an employee is an HCE under either of two tests. The ownership test picks up anyone who owned more than 5% of the business at any point during 2025 or 2026, no matter their pay.³ The compensation test picks up anyone who earned more than $160,000 in 2025. The employer can optionally narrow that second group to the top-paid 20% of employees who crossed the threshold.⁴

Key Employees

Key Employees are a separate category used only for the Section 125 concentration test. For 2026, they are:

Officers earning more than $235,000 in annual compensation⁵
Anyone owning more than 5% of the business
Anyone owning more than 1% of the business and earning more than $150,000 (this $150,000 figure is fixed and does not adjust for inflation)⁶

The Three Cafeteria Plan Tests

A cafeteria plan that includes HSA contributions must pass three tests, and they look at the whole plan rather than the HSA piece alone.

Eligibility

The eligibility test asks whether enough non-highly-compensated employees can actually participate. A safe harbor exists: the plan passes if it benefits a group satisfying the Section 410(b) classification test, no employee has to complete more than three years of service to become eligible, and participation is not conditioned on reaching age 21.⁷

Contributions and Benefits

This test ensures the actual value of benefits elected by HCEs does not significantly outrun what NHCEs receive. Contribution formulas and benefit menus cannot be structured to channel more value to the HCE group. The statute includes a safe harbor for health benefits that keys off the cost of coverage for the majority of similarly situated HCEs, with any contributions above that level required to bear a uniform relationship to compensation.⁷

Key Employee Concentration

The concentration test fails if the qualified benefits going to all Key Employees exceed 25% of the qualified benefits going to all employees under the plan.⁷ Small companies trip here most often. When a few owners and officers make up a sizable share of the workforce, their own benefit elections can push past 25% without any intentional favoritism in plan design.

Simple Cafeteria Plan Safe Harbor

Employers with 100 or fewer employees who received at least $5,000 in compensation during the preceding year can adopt a “simple cafeteria plan” under Section 125(j). A simple cafeteria plan is treated as automatically passing all three tests, provided the employer makes minimum contributions for every eligible employee. For small employers that qualify, this eliminates annual testing.

The Comparability Rules for Direct Contributions

Where contributions bypass a cafeteria plan, Section 4980G imposes a very different kind of requirement. Instead of testing outcomes across groups, it requires near-uniform contributions to every comparable employee.

What “Comparable” Means

The employer must contribute either the same dollar amount or the same percentage of the HDHP annual deductible to every employee in the same category.⁸ Only two factors allow variation:

Coverage tier: self-only, self-plus-one, self-plus-two, or self-plus-three-or-more. Higher tiers cannot receive less than lower tiers.⁹
Employment status: full-time (30 or more hours per week) versus part-time. Each group is tested separately.⁹

Contributions cannot vary by age, pay, tenure, or anything else. Employees eligible for only part of the year receive a prorated amount based on months of eligibility.

Matching Contributions Fail Automatically

This is the trap that catches employers most often. You cannot satisfy the comparability rules by matching each employee’s own HSA contributions. Because employees contribute different amounts, an identical match formula produces different employer contributions, which is not comparable.⁹

If you want to offer a match, it has to run through a Section 125 cafeteria plan. Matching contributions made through a cafeteria plan are exempt from the comparability rules entirely and are tested under Section 125 instead.¹⁰

Collectively Bargained Employees

Employees covered by a collective bargaining agreement that addressed health benefits in good-faith bargaining are not “comparable participating employees” and drop out of the comparability analysis entirely.¹¹

Related Employers Are Treated as One

Businesses that share common ownership or close service relationships cannot split employees across entities to escape testing. Under Section 414(b), (c), (m), and (o), all employees of a controlled group or affiliated service group are treated as working for a single employer.¹² The comparability regulations make this explicit for Section 4980G as well.⁸

The usual triggers are parent-subsidiary chains built on 80% stock ownership, brother-sister groups with common ownership meeting specific thresholds, and affiliated service groups in fields like healthcare, law, accounting, and consulting where entities regularly serve each other or share highly compensated staff. Any employer with related entities should map those relationships before running a test. Testing one entity in isolation when a controlled group exists almost guarantees a failure once the IRS looks at the whole picture.

What Happens When You Fail

The penalty structures are not comparable to each other. One hits the employees who benefited; the other hits the employer across the board.

Cafeteria Plan Failures

When a cafeteria plan fails any of the three tests, the affected HCEs or Key Employees lose the pre-tax treatment of their benefits for the plan year. They must include the value in taxable income even if they elected only qualified benefits. NHCEs and non-Key Employees are untouched.⁷

In practice, an HCE who directed pre-tax salary reductions into an HSA would owe income tax and payroll tax on those amounts retroactively, and the employer would owe additional payroll tax on the reclassified income. Catching the problem during the plan year and expanding NHCE participation or adjusting HCE elections before year-end usually heads off the tax hit.

Comparability Failures

A comparability failure triggers an excise tax equal to 35% of the total amount the employer contributed to all employee HSAs for the calendar year. It is not 35% of the shortfall or 35% of the shortchanged employees’ contributions. It is 35% of every HSA dollar the employer put in that year.¹⁰

Employers can avoid the tax by correcting the failure before April 15 of the year after the calendar year of the non-comparable contributions. Correction means contributing to the shortchanged employees’ HSAs to bring them up to comparable levels, plus reasonable interest. The IRS treats interest calculated at the federal short-term rate as reasonable.¹¹ The IRS may also waive part or all of the excise tax where the failure was due to reasonable cause and not willful neglect.⁸

Reporting the Excise Tax on Form 8928

An employer that owes the 35% excise tax reports it on IRS Form 8928. The filing deadline is the 15th day of the fourth month following the calendar year of the non-comparable contributions, which usually falls on April 15.¹³

A Form 7004 extension is available for the filing itself, but it does not extend the payment deadline. The tax is still due on the original date.¹³

Picking the Right Structure

Direct contributions outside a cafeteria plan are simple to administer: every comparable employee gets the same flat amount, and there’s no annual Section 125 testing. The downsides are real. No matching, no variation by compensation or tenure, and a 35% excise tax on the entire employer contribution pool if anything goes wrong.

A cafeteria plan requires more administrative work and annual testing, but it allows matching contributions, salary reduction elections, and more flexible contribution formulas. If a cafeteria plan fails testing, the tax consequences land on HCEs and Key Employees rather than the employer’s full contribution. For employers with a mix of highly compensated and rank-and-file staff, the cafeteria plan route typically gives more design flexibility while keeping compliance risk manageable.

Employers switching from direct contributions to a cafeteria plan structure should make the change at the start of a new plan year rather than mid-year. An employer that already runs a cafeteria plan for premiums or FSAs can usually add the HSA contribution as another benefit option within the existing plan document.

1
U.S. Department of the Treasury. Treasury and IRS Issue Final Regulations on Employer HSA Contributions
2
Office of the Law Revision Counsel. 26 U.S. Code 4980G – Failure of Employer to Make Comparable Health Savings Account Contributions
3
Internal Revenue Service. Identifying Highly Compensated Employees in an Initial or Short Plan Year
4
Internal Revenue Service. Notice 2024-80 – 2025 Amounts Relating to Retirement Plans and Other Items
5
Internal Revenue Service. COLA Increases for Dollar Limitations on Benefits and Contributions
6
eCFR. 26 CFR 1.416-1 – Questions and Answers on Top-Heavy Plans
7
Office of the Law Revision Counsel. 26 U.S. Code 125 – Cafeteria Plans
8
Justia Law. 26 U.S. Code 4980E – Failure of Employer to Make Comparable Archer MSA Contributions
9
U.S. Department of the Treasury. Final Regulations on Employer Comparable Contributions to Health Savings Accounts
10
Federal Register. Employer Comparable Contributions to Health Savings Accounts Under Section 4980G
11
Internal Revenue Service. Internal Revenue Bulletin 2006-33
12
Internal Revenue Service. Controlled and Affiliated Service Groups
13
Internal Revenue Service. Instructions for Form 8928