Top-paid group election question; it does not overrule the ownership or more than 5% of a company, correct?

[Guest Enda80]

http://www.mhco.com/FAQs/FAQ-TH_Top-Paid5%25_070904.htm

"Even when using the “top-paid group election” to determine highly compensated employees, the 5% owners rule must be considered since 5% owners may not be in the top 20% group. How can these rules be reconciled? Email Alert 2004-14 07/09/04

The highly compensated group consists of individuals who own more than 5% of the business entity in either the current plan or the prior year, and employees who received compensation in excess of $80,000 (as indexed--$90,000 in 2003) the prior plan year. The top-paid group election permits the employer to limit the highly paid group to owners and the top 20% of employee when ranked by compensation."

Do the paragraphs above accurately represent regulations? Can anyone provide passages from official literature to buttress the above?

[Mike Preston]

The text accurately reflects the rules. You'll just need to pull the regs at 414(q) to see that to be the case. I've always found the phrases a bit confusing, though, because the use of the word "may" can be misinterpreted. A quick example:

10 employees and therefore the top 20% is 2. Consider the 10 employees and their ownership and comp as:

1: 50% $200,000

2. 00% $200,000

3. 00% $150,000

4 50% $120,000

Numbers 5 through 10: 0% $50,000

In this case we find that number 4 is a more than 5% owner but is not in the top-20. The language cited is meant to say that even though number 4 is not in the top 20% that person is nonetheless an HCE.

So, there are 3 HCE's based on the above using the top 20 election (1, 2 and 4)

If not making the top 20 election, then there are 4 HCE's.