Employee Definitions

To perform compliance tests for a qualified retirement plan, a determination of which employees are Highly Compensated Employees and which are Key Employees must be made.

Click on the links below for the definitions.
Highly Compensated Employee
Key Employee

Highly Compensated Employee (HCE)

For years beginning in 1997 and later, an employee will be considered highly compensated if he or she:

Was a greater than 5% owner (actually or constructively under the rules of Code Section 318, see below) at any time during the current year or the preceding year, or
Had compensation from the employer in excess of $105,000 for 2008, and if the employer so elects, was in the top-paid group (i.e., top 20 percent of employees by compensation) of the employer for the preceding year.

Top-paid group election. Employers may make a top-paid group election for a determination year, under which an employee (other than an employee who has been a greater than 5-percent owner at any time during the determination year or the look-back year) who earned compensation in excess of the applicable amount as described above for the look-back year will be a highly compensated employee only if the employee was in the top-paid group for the look-back year. An employer is not required to make a separate filing or notify the IRS that the top-paid group election has been made. However, once the top-paid group election is made, it will apply for all subsequent years, until changed by the employer. This election must be made in the plan document when it is drafted. Some definitions (references are to code sections):

414(q)(3) TOP-PAID GROUP.—An employee is in the top-paid group of employees for any year if such employee is in the group consisting of the top 20 percent of the employees when ranked on the basis of compensation paid during such year.

414(q)(4) COMPENSATION.—For purposes of this subsection, the term "compensation" has the meaning given such term by section 415(c)(3) .

414(q)(5) EXCLUDED EMPLOYEES.—For purposes of subsection (r) and for purposes of determining the number of employees in the top-paid group, the following employees shall be excluded—

414(q)(5)(A) employees who have not completed 6 months of service,

414(q)(5)(B) employees who normally work less than 17 ½ hours per week,

414(q)(5)(C) employees who normally work during not more than 6 months during any year, 414(q)(5)(D) employees who have not attained age 21, and

414(q)(5)(E) except to the extent provided in regulations, employees who are included in a unit of employees covered by an agreement which the Secretary of Labor finds to be a collective bargaining agreement between employee representatives and the employer.

*Compensation amount adjusted for inflation. The compensation amount is adjusted for inflation. Click here for a chart.

POINTER

By electing to treat employees in the top 20% of compensation as highly compensated, an employer may be required to include fewer employees in the highly compensated employee group. As a result, employees who are still relatively highly paid may be categorized as non highly compensated, thereby increasing the plan's chances of passing the nondiscrimination tests.

In addition, for employees in the same general salary range, an employer may be able to designate those employees with higher benefit percentages as being in the non highly compensated group, which may also enable it to pass the nondiscrimination tests more easily.

Determination of HCE on controlled group basiS. The identity of the highly compensated employees is to be determined on a controlled group basis. Also, employees who are treated as highly compensated employees are to be determined on a controlled group basis.

Code Section 318. Members of family (this applies only to the determination of greater than 5% owners)--

(A)In general. --An individual shall be considered as owning the stock owned, directly or indirectly, by or for--

(i) his spouse (other than a spouse who is legally separated from the individual under a decree of divorce or separate maintenance), and

(ii) his children, grandchildren, and parents.

(B) Effect of adoption. --For purposes of subparagraph (A) (ii), a legally adopted child of an individual shall be treated as a child of such individual by blood.

Note: The spouse of a family member of a Highly-compensated employee (in-law) where the family member does not directly own any stock is not considered to be a highly-compensated employee.

Key Employee

(revised to apply for Plan Years after 2001)

HOW RELEVANT:

Top-heavy testing for qualified plans and the 25% benefits test for Flex Plans.

DEFINITION - Code Section 416(i):

An employee is a key employee if s/he meets any one of three tests below, at any time during the plan year :

The employee is an OFFICER who makes more than $150,000 (the 50% of the defined benefit pension plan annual benefit limit reference is gone for this purpose). This number is adjusted from time to time for Cost of Living increases. Click here for a chart.
Any greater than 5 percent owner of the employer.
Any greater than 1 percent owner who has compensation over $150,000.

Note: the determination of whether a plan is top-heavy for a plan year is made as of the last day of the preceding plan year.

Controlled group and affiliated service group rules do NOT apply in determining ownership for the determination of key employee status.

An individual is considered as owning any stock owned directly or indirectly by or for his spouse, children, grandchildren, and parents (code Section 318 rules, same as HCE). Technically, a "5-percent owner" or a "one-percent owner" is a person who owns "more than 5%" or "more than 1%" - Code §416(i)(1)(B). The spouse of a family member of a key employee (in-law) where the family member does not directly own any stock is not considered to be a key employee.

Company officers

Company officers are generally administrative executives who are employed in regular and continued service. The authority of the employee and not the employee's title is determinative of whether the employee is an officer. In addition, officer status is based upon the responsibilities of the individual to the employer for whom he or she is directly employed, and is not affected by whether the employer is a member of a controlled group or an affiliated service group.

Limit on number of key employee officers

The number of officers who may be considered key employees is limited to the greater of 3 employees or 10 percent of all employees, but in no event will more than 50 employees be considered key. Specifically, if the employer has less than 30 employees (including part-time employees), no more than 3 officers may be treated as key employees. If the employer has more than 30, but less than 500 employees, no more than 10 percent of the employees may be treated as key employee officers. Finally, if the employer has over 500 employees, the maximum number of officers who may be key employees is 50.

The officers who will be treated as key employees are those who earned compensation in the plan year in excess of the applicable dollar amount (currently $150,000) and who had the largest annual amount of compensation during the plan year. Owners who are also officers are still counted as officers for this purpose.

In general, an employee who is not an owner or officer (or a family member of an owner) is not a "Key Employee".

"Compensation" is 415 compensation which is defined as all compensation from the Employer for the year ADDING BACK IN cafeteria plan reductions, 401(k), SARSEP, and 403(b) salary deferrals; in other words, gross compensation is used to determine Key Employee Status (HCE status, also). This is basically Box 3 on form W-2 plus deferrals.

Note: 415 Compensation is used to determine the amount of top-heavy minimum allocation or accrual for each employee who is supposed to receive such minimum. This is compensation for the entire Plan Year (even if the Participant enters mid-year).

For non-calendar year plans, the compensation thresholds are those in effect at the beginning of the Plan Year.

— Information reviewed on 9/18/2009