Highly Compensated Employee

[Guest Rutager]

I have a question - I have an employer whose plan fails 401(k) testing and is questioning everything about the test - including the definition of an HCE. We provided a definition of HCE for which he came back with the following information:

[color="#8B0000"]The Pension Protection Act of 2006 has changed the definition of a highly compensated employee. There are now four considerations:

1) owning more than 5% of the stock (old)

2) has compensation in excess of IRC %414(g) limitation (old)

3) is among the highest paid 35% of all employees following the rules of IRC %105(h) (new)

4) is among the top-5 highest paid officers of the company (new)[/color]

I can't find where he is getting items #3 & #4 above - Is this correct? I could not find any information on this in the ERISA outline book - does anyone know what he is referring to?

[ERISAnut]

Your plan document will define (in exact terms) what an HCE is.

[jpod]

All I can tell you is that the PPA did not touch 414(q) and the definition of HCE therein. I don't know where he went astray, but the definition of HCE for 401k and 401m testing is no different than what it was before the PPA.

[rcline46]

The last 2 definitions you will note come from IRC105, which has to do with insurance and cafeteria plans and are NOT related to qualified plans.

[Kevin C]

It looks like he is combining two different definitions of HCE that are used for different purposes. Section 105 is titled Amounts Received Under Accident and Health Plans. His items 3) and 4) come from 105(h)(5). Although 105(h)(5)© is the highest paid 25%, not 35%.

As jpod said, the definition of HCE for a 401(k) plan is in section 414(q). PPA did not change it.

414(q) HIGHLY COMPENSATED EMPLOYEE. --

414(q)(1) IN GENERAL. --The term "highly compensated employee" means any employee who --

414(q)(1)(A) was a 5-percent owner at any time during the year or the preceding year, or

414(q)(1)(B) for the preceding year --

414(q)(1)(B)(i) had compensation from the employer in excess of $80,000, and

414(q)(1)(B)(ii) if the employer elects the application of this clause for such preceding year, was in the top-paid group of employees for such preceding year.

The Secretary shall adjust the $80,000 amount under subparagraph (B) at the same time and in the same manner as under section 415(d), except that the base period shall be the calendar quarter ending September 30, 1996.

[PLAN MAN]

Copied from PPA:

[PPA §863] (a) In General- Section 101 of the Internal Revenue Code of 1986 (relating to certain death benefits) is amended by adding at the end the following new subsection:

`(j) Treatment of Certain Employer-Owned Life Insurance Contracts-

`(1) GENERAL RULE- In the case of an employer-owned life insurance contract, the amount excluded from gross income of an applicable policyholder by reason of paragraph (1) of subsection (a) shall not exceed an amount equal to the sum of the premiums and other amounts paid by the policyholder for the contract.

`(2) EXCEPTIONS- In the case of an employer-owned life insurance contract with respect to which the notice and consent requirements of paragraph (4) are met, paragraph (1) shall not apply to any of the following:

`(A) EXCEPTIONS BASED ON INSURED'S STATUS- Any amount received by reason of the death of an insured who, with respect to an applicable policyholder--

`(i) was an employee at any time during the 12-month period before the insured's death, or

`(ii) is, at the time the contract is issued--

`(I) a director,

`(II) a highly compensated employee within the meaning of section 414(q) (without regard to paragraph (1)(B)(ii) thereof), or

`(III) a highly compensated individual within the meaning of section 105(h)(5), except that `35 percent' shall be substituted for `25 percent' in subparagraph © thereof.

And Code Section 105(h)(5):

(5) Highly compensated individual defined

For purposes of this subsection, the term “highly compensated individual” means an individual who is—

(A) one of the 5 highest paid officers,

(B) a shareholder who owns (with the application of section 318) more than 10 percent in value of the stock of the employer, or

© among the highest paid 25 percent of all employees (other than employees described in paragraph (3)(B) who are not participants).

Just follow the trail.

[XTitan]

I have a question - I have an employer whose plan fails 401(k) testing and is questioning everything about the test - including the definition of an HCE. We provided a definition of HCE for which he came back with the following information:

[color="#8B0000"]The Pension Protection Act of 2006 has changed the definition of a highly compensated employee. There are now four considerations:

1) owning more than 5% of the stock (old)

2) has compensation in excess of IRC %414(g) limitation (old)

3) is among the highest paid 35% of all employees following the rules of IRC %105(h) (new)

4) is among the top-5 highest paid officers of the company (new)[/color]

I can't find where he is getting items #3 & #4 above - Is this correct? I could not find any information on this in the ERISA outline book - does anyone know what he is referring to?

He's giving you the definitions for the COLI Best Practices provisions. These are the requirements for COLI to have tax free death benefits and is completely unrelated to the definition of HCE for any other purpose.

[GBurns]

Rutager

Why not just ask him where he got his definition from before you start trying to find it ? That way you can tell him if it is applicable to this situation or not.

[GMK]

Just my opinion, but this feels like a case where Rutager is wise to know the answers before questioning the employer about the source of a definition.

Rutager is likely to get an answer from the somewhat desperate employer like: "I read it somewhere. Don't you know about it? Why didn't you use it?" It'll be an easier situation if Rutager can calmly respond with the facts.

[GBurns]

That would be true if he was seeking answers but according to his OP he is seeking to find the source of the employer's quote. How will he ever be sure that he has found it ?

It leaves him open to finding the wrong source, which would make his response , to the employer, questioned. I can just imagine the employer saying, "That is not what I was talking about. I thought you knew about these things.".

[K2retire]

Being completely ignorant on matters related to life insurance, the OP sounded to me like an inept attempt to describe a top paid group election.