Short answer: If the plan favors key employees in eligibility or benefits, the key employees lose the $50,000 exclusion and are taxed on the full cost of their coverage, using the greater of the actual premium or the IRS table cost. Rank-and-file employees keep the normal treatment.
For 2026, a key employee is an officer with annual pay over $235,000, a 5% business owner, or a 1% business owner with pay over $150,000. A former employee who was a key employee at retirement or separation stays one.
The plan does not favor key employees as to participation if at least one of these is true: it benefits at least 70% of employees; at least 85% of participants are not key employees; or it benefits a classification that does not favor key employees. Employees with less than 3 years of service, part-time and seasonal employees, certain nonresident aliens and some collectively bargained employees are left out of the test. As to benefits, everything available to key employees must be available to the other participants; coverage set as a uniform multiple of pay is not discrimination.
The common trap is a small company that insures the principals for a salary multiple and everyone else for a small flat amount. If the plan fails, the full cost of key employees’ coverage goes into wages for income tax and Social Security and Medicare.