Can a plan participant be considered a "Five percent owner"

[billfgrady]

Does an employer who has made a 414(q)(1)(B)(ii) election to limit the definition of highly compensated employees to the top paid group of employees for the year include participants who would otherwise qualify as "highly compensated employees" under Section 414(q)(1)(A) as "five percent owners" when determining which employees are in the the top paid group?

To illustrate, a group consists of ten employees, eight of which qualify as five-percent owners AND have plan compensation in excess of $170,000 for the 2001 plan year, and two of which who are not five-percent owners and receive plan compensation of $100,000 and $60,000, respectively. Does the employer include the eight five-percent owners in determining the top 20%? If not, does the employee who receives plan compensation of $100,000 qualify as a HCE (i.e., can the employer round up to 1 although 20%x2=.4)? Any help is much appreciated.

[Jean]

I don't think the top paid group election is going to help your company. Generally, all eligible employees will be included in determination of the top 20%.

10 employees x 20% = 2 HCEs for the purposes of the compensation definition.

The 8 employees who are 5% owners are also HCEs.

If the top paid group election is not used, there are 9 HCEs: 8 for ownership and 1 additional that was not classified as a 5% owner, but does earn above the income limit.

If the top paid group election is used, there are 8 HCEs: 2 for compensation and an additional 6 because of ownership.

[billfgrady]

Thanks, Jean. That's what I feared. It looks as if we'll need to amend the plan to get rid of the election. The problem occurs with the employee earning $100,000. That employee doesn't defer at all.

Taking it back a bit further, I want to make sure I've analyzed the "five-percent ownership" rules correctly. The structure of ownership here is what is commonly referred to as the "satellite structure." There is a group corporation (the employer) which contracts on an independent contractor basis with eight satellite service corporations (each professional is incorporated as a personal service corporation, which is owned 100% by the incorporating individual). As I indicated earlier, there are eight individuals who I am analyzing under the "five-percent ownership" rules. Six of the eight own well in excess of 5% of the group corporation. Clearly, they classify as "highly compensated." On the other hand, two of the eight only have a 1% ownership interest in the group corporation. My understanding of the rules is that these two will also be treated as 5% owners under 1.414(q)-1T, Q&A 8 because they own 100% of their respective "satellite" service corporations. Any thoughts here?

[Brian Gallagher]

the 5% owner and the dollar limitation are two mutually exclusive criteria for the determination of an HCE. it is one OR the other. so just because someone is in one category, doesn't mean that he or she is not precluded from being considered in the other.