Is he a more than 5% owner?

A 401k plan owns company stock, in fact owns 95% of the company stock. One participant has more that 5% of the company stock within his account balance, no company stock outside plan.

Is he a more than 5% own of the company?

Thanks,

Attribution of ownership for purposes of determining who is an HCE, key employee, or required to take an RMD without regard to whether they have separated from employment, is determined under IRC 318.

318(a)(2)(B)(i) reads:

Quote

Stock owned, directly or indirectly, by or for a trust (other than an employees’ trust described in section 401(a) which is exempt from tax under section 501(a)) shall be considered as owned by its beneficiaries in proportion to the actuarial interest of such beneficiaries in such trust.

Qualified plan trusts are specifically exempt from this attribution. The participant in your example is not considered a 5% owner for the purposes mentioned above.

Thanks for confirming my understanding. 

Does anyone remember whether Congress had a reason (or even an imagined reason) for setting up 5% as a line that treats a participant unlike an employee who need not begin a distribution if she is not yet retired?

@Peter Gulia, as best I recall, the creation of Top-Heavy rules (TEFRA, 1982) was the first congressional attempt to quantify the concept of "highly paid".  They called it Key Employee.  Just a few years later (I think it was TRA86), they created the HCE definition, and greatly expanded its use.  Was there a reason?  I'm not privy to the discussions behind the scenes, but the 5% threshold was likely a compromise.  In like fashion, it's likely the TH threshold of 60% was also a compromise. 

Students of history will note that TH (and the entire TEFRA legislation) grew out of some significant bad publicity with small (often very small) plans providing 80%-90% of the benefit (and/or account balance) to the owner.  This percent increased if the owner's spouse was also covered.  Therefore, Congress had to do something!  Never mind that the plan design(s) were otherwise "vanilla", and the high percentages were due (almost entirely) to the longer service/employment of the owner.  The later HCE creation was in conjunction with a "beefed-up" change in IRC 401(a)(4) and congressional attention to the concept of "non-discrimination".

Side note, IMHO, (1) the implementation and use of HCE should have, but did not, alter the use of Key Employee, and (2) congress (and the regulators at DOL and IRS) have done a poor job of coordinating the smorgasbord of statutes and regulations that come under the broad umbrella of "non-discrimination".

david rigby has excellent recall.  The story goes back even further for the history buffs and those who worked with H.R. 10 or Keogh plans.

Attached is a GAO report from 2000 titled "Top-Heavy" Rules for Owner-Dominated Plans.  The background section provides a provenance of the concept starting with noting that "Congress first legislated requirements for nondiscrimination in pension plan coverage of a firm’s employees in 1942".

The narrative continues with "[b]efore 1962, sole proprietors, partners, and the self-employed were prohibited altogether from participating in tax-qualified pension plans, though as employers they could establish a plan for the benefit of their employees. In contrast, shareholder-employees in corporations could participate in qualified plans..."

After 1962, plans created by unincorporated “owner-employees” became eligible for tax qualification with owner-employee participation in the plan, but the plans were subjected to both the nondiscrimination rules and a second, more restrictive set of requirements for equitable apportionment of contributions and benefits."  This was the predecessor of current top heavy rules.

"The current top-heavy rules came about as part of the Tax Equity and Fiscal Responsibility Act of 1982, when the Congress decided that additional restrictions on owner-dominated plans should not be based on corporate versus non-corporate business structures but on whether any plan’s delivery of contributions and benefits was “top-heavy” in favor of owners and officers."

The report also includes a compare-and-contrast commentary of nondiscrimination rules versus top heavy rules which in part links the 5% ownership in the definition of Highly Compensated Employees to the 5% ownership in the definition of Key Employees.

Section 242 of TEFRA added 401(a)(9)(A) which linked the RMD ownership to the top heavy rules by referencing "key employee":

SEC. 242. REQUIRED DISTRIBUTIONS FOR QUALIFIED PLANS.
(a) GENERAL R U L E - Paragraph (9) of section 401(a) requirements for qualification) is amended to read as follows:
(9) REQUIRED DISTRIBUTIONS.—
(A) BEFORE DEATH.—A trust forming part of a plan shall not constitute a qualified trust under this section unless the plan provides that the entire interest of each employee
(i) either will be distributed to him not later than his taxable year in which he attains age 70 1/2 or, in the case of an employee other than a key employee who is a participant in a top-heavy plan, in which he retires, whichever is the later, ..."

“Top-Heavy” Rules for Owner Dominated Plans.pdf

David Rigby and Paul I, thank you for this wonderful history lesson and insight.