The 55% Average Benefits Test is one of the nondiscrimination tests that employers sponsoring a Dependent Care Flexible Spending Account (Dependent Care FSA) must satisfy under Internal Revenue Code Section 129. Please read below for key details on what has been proposed to change and Wrangleās process for running the nondiscrimination testing.
Purpose of this test
The purpose of the test is to ensure that the benefits provided through the plan do not disproportionately favor highly compensated employees (āHCEsā) over non-highly compensated employees (āNHCEsā).
Whatās changing?
The new proposed regulations provide significant relief by clarifying that only employees who actually participate in the Dependent Care FSA must be included in the Average Benefits Test calculations.
Key Note: Employees who are eligible for, but do not elect or receive Dependent Care FSA benefits, are no longer required to be counted for purposes of this test.
How will this impact the employer?
This change is expected to improve nondiscrimination testing outcomes for many employers substantially. By limiting the testing group to actual participants, the calculation more accurately reflects the distribution of benefits among employees who are using the program. For employers that previously struggled to pass the test due to low participation among NHCEs, the revised methodology may significantly reduce testing failures.
As a result, employers may experience fewer situations in which HCEs must have benefits reclassified as taxable income or face reduced election limits. The proposed regulations therefore represent a meaningful simplification of the testing process. This may allow more employers to offer Dependent Care FSA benefits without the ongoing concern of recurring Average Benefits Test failures.
When does this go into effect?
We generally anticipate that final regulations may be issued before the end of 2026.
Please note: While the Treasury Department and IRS have not provided a specific timeline for issuing the final regulations, it is generally expected to be released after consideration of public comments and hearing testimony.
What has been in place before the proposed changes?
Historically, this test has been particularly challenging for employers because of the way the regulations required the calculations to be performed. Under prior guidance, employers generally had to include all non-excludable employees in the testing population, regardless of whether those employees actually participated in the Dependent Care FSA.
As a result, a large number of employees with no elections or reimbursements were included in the calculation, often reducing the average benefit level for NHCEs and making it difficult for plans to satisfy the required 55% threshold.
When a plan failed the Average Benefits Test, the consequences fell on the HCEs. Employers often had to take corrective action either by:
- Treating a portion of the HCEs’ Dependent Care FSA reimbursements as taxable income, or
- Imposing a reduced election limit or contribution cap on HCE participants to improve testing results and reduce the likelihood of future failures.
Wrangleās approach for dependent care FSA nondiscrimination testing
Wrangle’s approach for clients with Dependent Care FSA plans subject to 2026 nondiscrimination testing is to provide flexibility in light of the recently proposed regulations. Clients may either
- Proceed with nondiscrimination testing under the current regulations or
- Defer testing until the IRS issues final regulations, which may result in more favorable testing methodologies and outcomes.
Employers electing to delay testing should be aware that, if the plan ultimately fails under the applicable final rules, there may be limited time remaining before the close of the 2026 tax year to implement corrective actions, such as reducing Highly Compensated Employee benefits. Accordingly, employers should weigh the potential advantages of waiting for final guidance against the risk of having a shortened correction window at year-end.
Feel free to reach out to the ERISA Desk Team at ERISADeskInfo@ascensus.com with any questions!