Former Key in top heavy test

[doombuggy]

I have a client who has dropped down to 57 1/2% on the top heavy test and is so happy he doesn't have to do the top heavy minimum for the 2016 plan year. He is now the sole owner, and his son also works there, but doesn't defer into the plan. The former co-owner sold his shares to the current sole owner in July 2014. Is he still counted as key for 5 years (2014 thru 2018) for determining Top Heavy?

My client is trying to do some planning to see if his son can defer, and someone I talked to thought this had changed...the number of years a non-key is counted in the test. Note the former co-owner still works there and still has assets in the plan.

[Lou S.]

Assuming a calendar year plan the former owner would be a key employee for 2014 (more than 5% owner in current year) and 2015 (more than 5% owner in the prior year if he was still employed) after which he would be a former-key employee (unless key by some other reason) and he would be ignored for TH testing in the numerator and denominator.

If the former owner sold his shares and separated from employment in 2014 he would drop off the test in 2015.

[Tom Poje]

if your are talking about going back in time to before 2002 (has it been that long!) then yes he would be key under the 5 year old rule. but currently he would be former key. since he is former key his assets are not used to determine if plan is top heavy at all, though if plan is plan is top heavy he would receive the minimum.

if I understand it correctly he was an owner on at least one point in 2014, so as of the determination date of 12/31/2014 he would still be counted as key, which sounds like what you described.

as of the determination date 12/31/2015 he is a former key so ceases to be included (he comes a former key) in 2016.

[Lou S.]

if your are talking about going back in time to before 2002 (has it been that long!) then yes he would be key under the 5 year old rule. but currently he would be former key. since he is former key his assets are not used to determine if plan is top heavy at all, though if plan is plan is top heavy he would receive the minimum.

if I understand it correctly he was an owner on at least one point in 2014, so as of the determination date of 12/31/2014 he would still be counted as key, which sounds like what you described.

as of the determination date 12/31/2015 he is a former key so ceases to be included (he comes a former key) in 2016.

Tom I disagree. 1/1/2015 - 12/31/2015 he is still a key employee due to owning more than 5% in the prior year (2014). He becomes a former key on 1/1/2016. I don't see anyway around that in the code & regs.

[Belgarath]

I think you are both saying (or meaning) the same thing - just saying it a little differently. At least that how I read your posts.

[rcline46]

The answer is, he is counted as KEY in 2015 and based on the OP notes, the plan is Top Heavy as of 12/31/2015 determination date and therefore a TH contribution is due in 2016.

Which is mean, because the former KEY caused it, and now gets the TH 2016 contribution.

[Mike Preston]

I don't think that is what the OP is saying at all. He definitively said the ratio as of 12/31/2015 was less than 60% but that was based on the interpretation that the ex-owner was still key. And while it isn't the same reasoning the OP used, the conclusion is the same: the ex-owner's account balance is used as key in the 12/31/2015 TH ratio. So, it looks like that ratio is less than 60% and the plan is not TH for 2016.

When the TH ratio is determined as of 12/31/2016 the ex-owner's account balance will neither be in the numerator nor the denominator and, in all likelihood, the TH ratio will be even less than what it was as of 12/31/2015.

[buckaroo]

I have read this a number of times and I am confused by the response.

416(I)(1)(A) states (in part) that a key employee means any employee who, at any time during the plan year"

416(I)(1)(A)(ii) states a 5-percent owner of the employer

I do not see anywhere where it speaks to ownership in the prior year.

Assuming a calendar year plan year:

1/1/2014 -- 12/31/2014 - The former owner was a more than 5% owner (sold ownership in 7/2014) and should be a key employee for determination date 12/31/2014.

1/1/2015 -- 12/31/2015 - The former owner was not a more than 5% owner (sold ownership in 7/2014) and should be a former key employee for determination date 12/31/2015.

What am I missing?

[Belgarath]

IRC 416(g)(4)© defines the determination date for a plan year to be the last day of the prior plan year. (except for the first plan year of a plan.)

So you are looking for employees who satisfy one of the key employee tests for the plan year that includes the determination date.

So, if you are doing a 2016 valuation, your key employees would be those who satisfied any of the key employee tests for 2015 (the plan year that includes the determination date.)

[doombuggy]

Yes, the former owner, "AW" sold his shares in July 2014. We had him as Key in 2014 (since he was a more than 5% owner in 2014). In 2015 he is listed as former key. I wasn't sure how long this was going to hang on and my cheat sheet is from before 2002.

So in essence, AW will remain a "former key" and only the owner and his son are keys at this point. Since the son has never deferred, if he does consider to start making deferrals, the plan might become top heavy again (it is not for 2016, at just over 57%). Thanks for the discussion!

[My 2 cents]

Yes, the former owner, "AW" sold his shares in July 2014. We had him as Key in 2014 (since he was a more than 5% owner in 2014). In 2015 he is listed as former key. I wasn't sure how long this was going to hang on and my cheat sheet is from before 2002.

So in essence, AW will remain a "former key" and only the owner and his son are keys at this point. Since the son has never deferred, if he does consider to start making deferrals, the plan might become top heavy again (it is not for 2016, at just over 57%). Thanks for the discussion!

Don't feel too bad about your cheat sheet dating back to before 2002. I think the IRS regulations are even older. [if anyone has seen any regulations dealing with the changes made to Section 416 by EGTRRA, please pass along a link!]

[LKSmoke]

Several years later, but a question that ties into the whole "when does a Key Employee become a Former Key Employee?"

Dad was 100% owner through 2019.  In 2020 two children became 50/50 owners.  Two other children are not owners for 2020, but are participating in the plan.

Dad retains his Key status through family attribution, but what about the 2 siblings who are longer Key through family attribution?  Do they become Former Keys in 2020 or 2021?

Thanks!