Key Employee Determination

[Gilmore]

A 401(k) plan has been approaching the 60% top heavy ratio for a few plan years. The current Key Employees, the owners and one long time Officer, have agreed not to defer until the top heavy test is completed each year, to avoid having to make a top heavy minimum.

For 2016 the ratio exceeds 60% for the first time. The Keys stopped deferring after 12/31/2015 and have decided among themselves not to defer in 2016.

The company is hiring an employee in 2016 whose job functions will classify the new employee as an Officer and the new employee will be eligible to defer in 2016. His compensation will exceed $170,000 in 2016, and no Officers are excluded under the 10% rule.

Question is, for 2016, although the new employee will most likely meet the Key Employee definition on the 12/31/2016 determination date for determining the 2017 Key Employees, am I correct that this employee IS NOT a Key Employee for the 2016 plan year, and would not trigger a top heavy required contribution if he defers in 2016?

Thank you.

[Belgarath]

Agree. (as an aside, any forfeiture issues in this plan? There can be some nasty surprises when a plan has forfeiture reallocations...)

[Tom Poje]

on the other hand, if there are no deferrals by key employees, the top heavy is the lesser of 3% or what key employees receive, so forfeitures would most likely be comp to comp anyway with no 'extra' to kick in

[Belgarath]

Most likely true, but you might have to then give to a bunch of people otherwise not eligible, due to less than 1000 hours, for example.

[Tom Poje]

ah, my favorite type of plan, in which you end up with a mess of people with account balances that are so small they are simply more of a bother.

[Gilmore]

Thank you for the confirmation that the new employee would not be a Key Employee for the 2016 plan year. No forfeiture issues, but appreciate the heads up on that.

[Gilmore]

Tom,

I appreciate your input on the forfeiture allocation, but would also appreciate your opinion on the main question, which is, if an Officer is hired in 2016, and the 2016 plan year is top heavy, and that Officer makes a deferral in 2016 and at the end of the year they end up with more than $170,000 in compensation, would they be considered a Key Employee for 2016 and trigger the minimum contribution, or are they not considered a Key Employee until 2017?

In Sal's book he discusses differing opinions with respect to who is a Key Employee for receiving a top heavy accrual. In the discussion he describes one opinion in which the Key Employees used for determining who is required to receive a top heavy contribution are the same Key Employees who are used to determine if the Plan is top heavy. So the Key Employees determined as of 12/31/2015 are the same Key Employees used to determine who is NOT a Key Employee for the 2016 top heavy contribution.

Contrasting that is a differing opinion, in which the Key Employees used in the 12/31/2015 are only used to determine if the plan is top heavy for 2016. Any other employee that meets the definition of a Key Employee on 12/31/2016 would be considered as a Key Employee for determining who is NOT a Key Employee for the 2016 top heavy contribution.

So in the contrasting view, if the Officer hired in 2016 makes more than $170,000 in 2016, and the plan does not provide the top heavy to Key Employees, the new Officer would not receive a top heavy contribution. Under that view I would think that if the Officer also deferred, he would trigger the need for a top heavy contribution to be made.

Sal does indicate that the first view, the one in which the new Officer would not be a Key Employee for 2016, seems to be the preferred view of the IRS, but I was wondering if you had ever come across a similar situation or your thoughts in general.

Thanks.

[Tom Poje]

As Mr T would say "I pity the fool" (who relies on my opinion!)

as close as I can find an answer is from the following:


2011 ASPPA Conference #47
Margaret became a participant in a 401(k) plan in the 2010 plan year, which ends December 31, 2010. For 2010, Margaret did not satisfy any of the key employee tests. The plan is top heavy for 2011 because the top heavy ratio exceeds 60%. The top heavy ratio is computed as of 12/31/2010, which is the determination date for the 2011 plan year. For that calculation, Margaret's account balance as of 12/31/2010 is treated as a non-key employee account balance. During the 2011 plan year, Margaret marries the majority owner of the company. This makes her a more-than-5% owner of the company by attribution. Does Margaret receive a top heavy minimum contribution for the 2011 plan year? Should she have received a top heavy contribution for the 2010 plan year even though the employer didn't fund the contribution until 2011 after Margaret already had married the owner?
IRS response. There is no guidance directly on point, but the most reasonable interpretation is that Margaret receives a top-heavy minimum contribution for 2011. For top-heavy purposes, a single determination date is prescribed by IRC § 416(g)(4) for determining both whether the plan is top-heavy and whether an employee is a key or non-key employee. While it would be intuitive to adjust this determination based on events occurring within the year after the determination date, this interpolates a condition that is not in the statute. Note that the House Report (H.R. Rep. No. 107-51) and Conference Committee Report (H.R. Conf. Rep. No. 107-84) accompanying EGTRRA § 613 both provide that the determination date is used for identifying who is a key employee in the following year.

well, of course such responses don't necessarily represent an actual Treasury position, but at least they offered an explanation for their logic on this one.

[Belgarath]

But beware! As always, make sure what the plan document says. Ours, for example (and I hate this provision) says that for purposes of determining who RECEIVES a top heavy allocation, it is based on the plan year for which the contribution is being made, and NOT the plan year containing the determination date.

[Gilmore]

Thank you both. Tom, is that conference question somewhere in the archives on ASPPA's website that I would be able to locate?

Thanks.

[Tom Poje]

for another discussion of the issue see slides 30 -33 of another presentation (which I found out on the internet) which discuss possible interpretations.

A few years ago I gave a similar presentation (which is why I was to pull the Q and A so quickly). I know the limitations of my research and so, would simply say, the waters are somewhat muddy in regards to the issue.

https://www.asppa.org/Portals/2/06-11-14%20Presentation.pdf

(of course if your document says keys included for top heavy it is a moot point.)

the Relius software offers the following choices

1.exclude current plan year keys

2. exclude keys as of top heavy determination date

so there is simply no 100% consensus.

top heavy presentation.pdf

[Gilmore]

Thank you very much!