If a Cafe Plan fails the nondiscrimination testing, what is the tax implication for highly compensated employees?

If a Cafe Plan fails nondiscrimination testing, it specifically indicates that the plan doesn't meet certain requirements regarding the benefits provided to highly compensated employees (HCEs) versus non-HCEs. When a plan fails these tests, one of the significant consequences is that the highly compensated employees must recognize the value of the benefits they received that were deemed excessive or discriminatory. As a result, they will be taxed on that value, reflecting an adjustment to their taxable income.

This taxation on the value of benefits means that any excess benefits received by HCEs could result in a higher taxable income for them, contrasting with the treatment of other employees who are not subject to these limitations. This process is designed to ensure that the benefits provided are equitable across different employee classifications and discourages plans from favoring highly compensated individuals disproportionately.