HCE threshold

[Guest non-tax pro]

Please confirm which HCE threshold is used for 2005 tax year ADP Test. 2004 gross wages are used for HCE determination, but it's unclear whether 2004's $90K or 2005's $95K is to be used.

I got a response from IRS 401K department. However, they didn't seem confident in their response. It's hard to tell what the original 414 (q) (1) $80K base year was because that threshold remained constant from 1997 through 1999.

ASIDE: also, if you know...why did the threshold drop drastically from $100K in 1996 to $80K in 1997? 2006's $100K is quite low compared to the current job market wages high escalation (a lot of line staff, non-management, in oil & gas field are exceeding that with big 2006 raises needed just to keep necessary staffing levels).

[stephen]

To determine HCEs for 2005 you look back to 2004 compensation and 2004 compensation limit. Thus, if an employee earmed more than $90,000 in 2004 they are an HCE for the 2005 plan year.

Most adoption agreements allow for the employer to elect top 20% rule which limits your plan to 20% HCEs. For example a firm that has 100 employees half of which earn more than $100,000 is only required to include 20 of them as HCEs if they make this election. Note, this is a very simple example and can only be made prospectively.

Also, if the company is already making an employer contribution of some knid they may want to consider a safe harbor plan as this would allow them to avoid ADP, ACP and Top Heavy Testing for years in which they are safe harbor.

I only have the last 10 years CODA posted at my desk and 1997 was $80,000.

[Archimage]

If I am not mistaken, SBJPA changed the limit for plan years starting in 1997.

[Guest non-tax pro]

IRS Publication 560 clearly states that preceding years compensation of more than $95,000 is the criteria.

Please advise if this IRS publication is not what the IRC's require. Stephen seems convinced that it's $90,000 (2004 HCE threshold) so this is confusing.

[stephen]

I stick by my previous post. Perhaps the IRS made a mistake in Publication 560 (page 4-5) and this should be $90,000 (instead of $95,000) from a previous year or in reference to 2006 returns.

[Dan]

It sounds like everyone is right, but the communication is complicated.

As Stephen said, if you are testing for the 2005 plan year, the HCE compensation threshold is based on 2004 earnings. So anyone who earned $90,000 or more in 2004 would be classified as an HCE for 2005.

Likewise, for a 2006 plan year, the HCE compensation level is $95,000 earnings in 2005.

Current year wages have no effect on the definition of HCE. The year immediately preceeding the one you are viewing is often called the look-back year. The compensation-component of the definition of a HCE being determined by earnings in the look-back year.

This can be a confusing concept. When you see a HCE compensation amount associated to a year, like $95,000 for 2005, that means if you earn $95,000 in 2005, you will be a HCE for 2006.

If the IRS didn't seem confident in their answer, sometimes they do not understand what we ask. Other times, they really don't know.

I hope I didn't muddy the waters.....

[Bird]

IRS Publication 560 clearly states that preceding years compensation of more than $95,000 is the criteria.

Because it's a 2006 publication. I agree with Dan and Stephen.

[stephen]

The odd thing is the Publication 560 (copy attached) on the cover states "For use in preparing 2005 Returns"

Then on page 5 - 6:

"Highly Compensated Employee. A highly compensated employee is an individual who:

Owned more than 5% of the interest in your business at any time during the year or the preceeding year, or

For the preceding year, recipient received compensation from you of more than $95,000 and if you so choose was in the top 20% of employees when ranked by compensation. This $95,000 amount increases to $100,000 in 2006."

I still say I am correct-

p560.pdf

[Guest non-tax pro]

More than that it carries back the current tax year threshold through 2002 Pub 560's (haven't taken time to look back further).

Because the base period being inflating is anchored at September 30, 1996 (i.e. $80K is already determined in lookback year for 1997). Then the Treasury publishes the threshold in October of the prior year even though they call it the next year's threshold.

...more confused. I'll keep digging because it's making a big difference for this year (wages have jumped dramatically).

[WDIK]

You might want to take your shovel and head over to 1.414(q)-1T, Q&A-3(c )(2).

[Guest mjb]

IRS notice 2005-75 states the HCE limit in IRC 414(q)(1) increases from 95,000 to 100,000 in 2006. 414(q)(1)(B) states that the term HCE means any employee who for the preceeding year had compensation in excess of (80,000) increased by as provided by the IRS for cost of living which is 100,000 in 2006. Therfore an HCE in 2006 is any employee who had compensation in excess of 100,000 in 2005. Q356 of Tax Facts concurs with the same answer. For 2005 the HCE comp amount was more 95,000 paid in 2004. What pub 560 is saying is that for the 2005 tax /plan year an HCE is an employee who earned more than 95,000 in 2004.

[WDIK]

And yet the same Q356 indicates that "[t]he applicable dollar amount for a particular determination or look-back year is the dollar amount for the calendar year in which the determination year or look-back year begins," which is from the temporary regs. (emphasis added)

[Guest non-tax pro]

Reading the actual HRA and amendments shows that the original $80K was set for 1996 lookback basis compensation comparison (1997 tax year), but got listed as the 1997 HCE threshold (1996 HCE threshold was actually $100K). Inflation is applied to this 1996 COLA basis just like the present $170K 415 DB limit and $14,000 457 deferral limit. The HCE threshold was raised to $95K in October 2004 for the 2005 tax year lookback (if you keep the years in order -- the COLA tables are confusing because the threshold is always shown for the pertinent tax year and therefore appears to miss one year of inflation if you use corresponding years listed in COLA tables; i.e. 2004 threshold for 2004 compensation).

I believe that the original basis premise has been forgotten and the COLA tables are being misunderstood. Unfortunately, there aren't many Plan Administrators around that go back that far -- at least they aren't doing the Testing and Reporting services.

Thanks for the leads, but this is becoming a lot of work for a novice. I would like to research further without a shovel!

How do I find Tax Facts Q356 online? Somehow I keep getting erroneous information. GUIDANCE APPRECIATED!

Thank you.

[Guest mjb]

WDIK: Will you please explain the significance of the reg you quoted.

Non tax: I dont see what is the difficulty in understanding the statutory languge of 414q1B- in any year the previous year's comp is used to determine who is an HCE. For 2006 an HCE's comp must exceed 100kpaid in 2005; for 2005 it was 95,000 paid in 2004. Since the 2005 pub 560 is intended to be used in preparing tax returns for 2005, the 95,000 amount is used to determine who was an HCE in 2005.

Tax Facts can be purchased from the National underwriter co by contacting them online. The temp regs are obsolete because they were issued before 414q was amended to mandate that HCE comp was determined by the prior yrs comp.

[Guest Pensions in Paradise]

Sorry MJB, you're wrong on this one. Please refer to the Pension Bible...ur...The ERISA Outline Book, under definition of Highly Compensated Employee.

[Guest mjb]

PP: I refer you to IRC 414(q)(1)(B). Do you have a citation of authority for your position. Could you please tell me why you (not some author) disagree with the IRS?

[Guest CharlieLaur]

I agree with Stephen & Dan (also with Sal Tripodi) that an employee would be considered an HCE in 2006 if he/she has compensation in excess of $95,000 in 2005.

If the regulations under 414(q) no longer have any merit, then I wonder why Tax Facts cites them in Q&A 356. Tax Facts also cites the information letter to Kyle N. Brown dated 12/9/99 which has always been one of my primary sources for my understanding of how to apply the annual COLA adjustments.

[Guest non-tax pro]

Can anyone forward a copy of the December 9, 1999 Information Letter to Kyle N. Brown? I'm hoping that it's a clear definitive answer from the Treasury.

There seems to be a lot of confusion in the industry. Non-Treasury authors/authorities and IRS tax assistants also seem full of erroneous information that can't be backed up (i.e. conjecture).

PP: please attach pertinent section of ERISA Outline Book and section author to clarify.

Here's my take from readily available history. Please educate me if you know otherwise or if you have more definitive documents (attachments appreciated).

The original Act's wording starts with $75K HCE threshold in 1987 (tax year; AKA determination year). After that it's indexed for inflation and given a a determination year value to compare with look-back year.

The 1997 HRA changed amount to "...preceding year....$80,000". The look-back or preceding year was 1996 compensation. But the HCE threshold was given as $80,000 which is the value for 1997 determination or tax year. Applying this forward would agree with IRS Pub 560 that 2004 compensation must be below $95,000 known by COLA tables as the 2005 HCE threshold. The 2005 label appears given even though the indexing is done in 2004 and stated in October 2004 as a value for that year, but called the determination year's threshold (started as $80,000 basis in October 1996 although labelled 1997 threshold). Following H.R.3448 Section 1431's wording forward from 1997 the $80,000 becomes $95,000 for 2005 determination year. The key words at the bottom of this section are "...except that the base period shall be the calendar quarter ending September 30, 1996." So the $80,000 thought of as the 1997 threshold is actually tied to the look-back year and indexed from it, not the determination year.

Aren't government regs great! I'm glad they've simplified the Code. Hopefully someone can produce a determining Treasury document. Does anyone work at EPTEGE Division?

So far I've just seen opinions. Isn't there anything definitive. The history appears to disagree with all but MJB.

[WDIK]

WDIK: Will you please explain the significance of the reg you quoted.

As a "non-lawyer" my opinion certainly cannot be relied upon to interpret language as complex as that found in Internal Revenue Code and Regulations. That being said, the previously cited regulation appeared pertinent because it seemed to be saying that you apply the dollar amount in effect for the calender year in which the look-back year begins for look-back year purposes.

Perhaps it is a lack of self-confidence, but I am always inclined to question my own understanding of an issue. It is troubling to me that there is not a consensus on this topic among sources that I consider reputable, such as The Pension Answer Book, Tax Facts, IRS Publication 560, McKay Hochman website, etc.

[Guest pensionadmin]

Corbel's Pension Library cites Reg. 1.414(q)1T,A3 as the source for determining the dollar threshhold. That paragraph says:

"(2) Applicable dollar threshold. The applicable dollar amount for a

particular determination year or look-back year is the dollar amount for

the calendar year in which such determination year or look-back year

begins. Thus, the dollar amount for purposes of determining the highly

compensated active employees for a particular look-back year is based on

the calendar year in which such look-back year begins, not the calendar

year in which such look-back year ends or in which the determination

year with respect to such look-back year begins."

Does that convince anyone that the dollar limit is the one for the look back year?

[Guest non-tax pro]

That is the confusing part of the exact wording of Reg. 1.414(q)1T,A3. Plus all the guidebooks just repeat it.

But the actual HRA was developed using the determination year HCE threshold values to replace the $80,000 or $75,000 (depending on which year's Act you're using, original or 1997 version) to compare with look-back year's compensation. Hence my confusion.

Plus employees are really questioning it because Pub 560 clearly states 2004 comp above $95,000 is the HCE qualifier. So a definitive answer is required. I was hoping the Kyle Brown letter might address this if someone can attach a copy -- much appreciated.

[Guest mjb]

There is nothing confusing about how the IRS applies the HCE $ amount for the lookback year if you read IRS guidance issued after the definition of who is an HCE was changed in 1996. See IRS notice 97-45 example 1:For determination year beginning April 1, 2000, the lookback year is the 12 month period from April 1, 1999 to March 31, 2000. In the 2006 determination year, an HCE is anyone who earned more than $100,000 in the lookback year that began in 2005, as stated in Pub 560. Also see Pension Answer book Q 3-3.

[stephen]

The Pension Answer Book Question 3:3 refers you to Q 3:7 and Q 3:8 (amongst others)

The section below is from Q 3:8.

"Thus, for plan years that began in 2005, the look-back year began in the 2004 calendar year, and the compensation limitation for determining HCE status was therefore $90,000. The compensation limitation for determining HCE status is $95,000 for plan years beginning in 2006, based on the look-back year beginning in 2005."

[Guest non-tax pro]

97-45 just says $80,000 (as adjusted). I need an example where the actual threshold is shown for a unique year where it changes (i.e. the 1997 threhold held @ $80 for several years, so the examples don't ensure whether the look-back or determination year threshold is applied).

Some Plans use $90,000 maximum and others like yourself and Pub 560 use $95,000 maximum for 2004 compensation as HCE threshold.

FYI, it was the IRS 401K department that said Pub 560 is in error.

I don't have Pension Answer Book. What does Q-3-3 specifically say? Does it list indexed thresholds in it's examples?

[stephen]

Pension Answer Book Q 3:8 attached

HCE_Determination.pdf