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Top-Heavy/Key-Employee question


Tom

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I'm checking the admin software on this which says the person is not key for 2023.  99% of our plans are small with owners/officers being the same and always >5%.  But now the top-heavy issue comes into question for a client with a non-owner officer.

Question:  For PYE 12/31/2023 the top-heavy determination date is 12/31/2022 and the plan is top heavy as of that date.  The employee in question is not an owner or officer in 2022 but became an officer 1/1/2023 (no ownership) and has $250,000 in comp for 2023.  I believe this person is non-key for 2023 and needs a top heavy contribution for 2023.  This is what our software indicates.  

Likewise if someone buys into a company in 2023 at over 5% (is not an officer) they would not be key for the year of their buy-in since the determination date of their status is the last day of the prior year. They would be non-key for 2023 and key for 2024.  (They would be HCE for 2023  however.)

Comments? Thank you!

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Have you determined whether this EE is exempt from all definitions of Key Employee?  IOW, you say the EE is "an officer", but have you reviewed the definition of both Key Employee and officer in regulation 1.416?  

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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Assuming he is an officer and his compensation is over the $ limit I'm not sure how he is NOT a Key employee in 2023. §416(i)(1)(A) says "at any time during the year".

I agree he was not a key for 2022 and would be a non-key as of the determination date of 12/31/2022 for determining if the Plan is top heavy for the 2023 plan year.

 

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The problem I'm having is things I'm reading say a key employee - is a >5% owner, >1% owner or officer with high comp "at any time during the plan year CONTAINING THE DETERMINATION DATE."  The person I mention above was none of those things at any time during the plan year (2022) which contains the determination date (12/31/2022) for the 2023 plan year.  So the person is not key for 2022 and first meets the requirements for key in 2023 but was not key as of 12/31/2022 which is the determination date for 2023.  This is what's making me think the person is not key for 2023 even though he is an officer in 2023 and makes $250,000.

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But... what is the regulatory definition of "officer"?

Hint: title means nothing.

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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The rule’s Q&A T-13 says this:

Q.   For purposes of defining a key employee, who is an officer?

A.    Whether an individual is an officer shall be determined upon the basis of all the facts, including, for example, the source of his authority, the term for which elected or appointed, and the nature and extent of his duties. Generally, the term officer means an administrative executive who is in regular and continued service. The term officer implies continuity of service and excludes those employed for a special and single transaction. An employee who merely has the title of an officer but not the authority of an officer is not considered an officer for purposes of the key employee test. Similarly, an employee who does not have the title of an officer but has the authority of an officer is an officer for purposes of the key employee test. In the case of one or more employers treated as a single employer under sections 414(b), (c), or (m), whether or not an individual is an officer shall be determined based upon his responsibilities with respect to the employer or employers for which he is directly employed, and not with respect to the controlled group of corporations, employers under common control or affiliated service group. A partner of a partnership will not be treated as an officer for purposes of the key employee test merely because he owns a capital or profits interest in the partnership, exercises his voting rights as a partner, and may, for limited purposes, be authorized and does in fact act as an agent of the partnership.

26 C.F.R. § 1.416-1/Q&A T-13 https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR686e4ad80b3ad70/section-1.416-1.

If the presence or absence of a job title that some might imagine suggests its wearer is an officer is not by itself dispositive:

How does a TPA classify whether a nonowner is an officer?

Do you:

1.     Just let your client fill-in a census using its own sense about who is or isn’t an officer?

2.    Write in your census request a plain-language explanation of the rule quoted above?

3.     Look at not only the yes-or-no response to the officer query but also the rest of the census information to discern whether your client’s responses seem to make sense?

4.    Do something else?

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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Our determination of whether a non-owner employee is a an officer and a key employee is in the realm of considering the facts and circumstances.

  • Yes, we ask the client to identify on the census who the client considers to be an officer. 
  • We look at the individual's compensation and ask for more details if we are not familiar with an individual who is designated as an officer.
  • We do not provide a written detailed explanation of the rules from Q&A T-13.
  • We do factor in our experience, relationships and interactions with long-standing clients.
  • For new clients, we do have a conversation our contacts about our census data request and discuss what it means to be an officer.
  • We do rely on our experience with certain types of businesses and typical management structures.

Applying a comprehensive analysis for all clients to determine who is or is not an officer would not be a practical use of our time or the client's time.  Sometimes in our industry we get carried away with over-analyzing something when we do not have to be 100% precise.  The reality (based on periodic analyses over the years) is the vast majority of plans with more than 15 participants are not top heavy.  Further, many small plans now use a design the provides a safe harbor for top heavy testing.

Note that Q&A T-39 says:

T-39 Q. Must ratios be computed each year to determine whether a plan is top-heavy?

A. No. In order to administer the plan, the plan administrator must know whether the plan is top-heavy. However, precise top-heavy ratios need not be computed every year. If, on examination, the Internal Revenue Service requests a demonstration as to whether the plan is top-heavy (or super top-heavy; see Question and Answer T-33) the employer must demonstrate to the Service's satisfaction that the plan is not operating in violation of section 401(a)(10)(B). For purposes of any demonstration, the employer may use computations that are not precisely in accordance with this section but which mathematically prove that the plan is not top-heavy.

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Is there a conflation of who is Key for the determination date? and who is Key during the year that the minimum is required? 
If I am Key in the plan year ending 12/31/2022, but not in 2023, wouldn't I be due a top heavy minimum for 2023?

Or are the regulations about who is key for determination date purposes say those same people are key for giving the minimum the following year?  

I'm a stranger on the internet. Nothing I write is tax or legal advice. 

I'd like a witty saying here, but I don't have any. When in doubt, what does the plan document say?

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The determination date for 2022 plan year was 12/31/2021 (assuming this is a calendar year plan).  Let's say for example on the determination date you were considered a Key employee based on having more than 5% ownership in 2021. 

Assume you were no longer an owner on 1/1/2022 and had no ownership throughout 2022.  The next determination date is 12/31/2022 to identify Key employees for the 2023 plan year.  On the 12/31/2022 determination date you are now a Former Key employee.  A Former Key employee's account is ignored when determining the Top Heavy Ratio

A Former Key is not a Key employee.  If the plan Top Heavy for 2023 you will get the Top Heavy Contribution.

You will remain a Former Key in future years unless subsequently you become Key again.

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Paul I, I understand what you are saying, and agree, that is my understanding as well. 

For others:

I was trying to point out to others that just because someone is key, or isn't key as of the determination date, doesn't impact their key status for the year that the top heavy minimum is due. I got the impression ( maybe I misunderstood some of the comments) that some were thinking that just because a person isn't key in 2022 means that they would need to get the TH min for 2023, even though their current status in 2023 is a Key employee. I disagree - someone's status as Key, non-Key, or Former Key for purposes of the TH determination don't impact their status as Key or Non-Key for purposes of giving the Top Heavy minimum the year after the determination.

I think that saying someone's Key status for the determination somehow carries forward to the actual Top Heavy year, is incorrect. 

I'm a stranger on the internet. Nothing I write is tax or legal advice. 

I'd like a witty saying here, but I don't have any. When in doubt, what does the plan document say?

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