key employee Which "plan year" do you use to determine keys for top-heavy

I apologize in advance if I've missed something in my cursory research of this, but here goes. Also, for simplicity I am assuming the employer in question only has DC plans, but I don't think that makes a difference.

Clearly, to determine whether a plan is top-heavy for a "plan year" you use account balances as of the "determination date," which also quite clearly is the last day of the plan year preceding the plan year for which the determination of top-heaviness, or not, is being made. E.g., to determine whether a plan is top-heavy for a calendar year 2019 plan year, you use balances as of 12/31/2018. There are potentially also certain addbacks to determination date account balances of keys and nonkeys for distributions that were made during the plan year preceding the year for which the top-heavy determination is made (i.e., in my example, during 2018 for the 2019 top-heaviness determination), or potentially during a 5-year period in the case of some distributions. See IRC secs. 416(g)(1), (3), and (4)(C). And of course you have aggregation rules.

So the above gives you your key and non-key participant balances for purposes of determining whether more than 60% belong to keys. But then you have to figure out whether those balances belong to keys or non-keys. IRC sec. 416(I)(1) [Note: the "I" in 416(I)(1) should be lower-case, but I can't make that happen; sorry]  tells you that the keys are the folks who meet certain requirements, e.g. percentage of ownership of the employer, "at any time during the plan year." Just looking at 416(I)(1) [see previous note], it would seem that the "plan year" being referred to for identifying keys is the current plan year, i.e. the year for which you are making the top-heavy determination, i.e. 2019 in my example. At least, that's what I think, because 416(g)(1) tells you that a plan is top-heavy "with respect to any plan year," and to me, when 416(I)(1) says "during the plan year," they are talking about the same plan year. So it seems to me that based on the statutory language you would use ownership and compensation in 2019 to determine who are your keys and non-keys, and then you would go back to 12/31/2018 to see what those folks' determined to be keys based on their 2019 facts had in the plan for purposes of the "more than 60%" test.

But Treas. reg. 1.416-1, T-12 seems to say pretty clearly that the "plan year" being referred to in 416(I)(1) is not the plan year for which you are making the determination (i.e., 2019 in my example), but rather 2018. It does this by adding "containing the determination date" to 416(I)(1)'s simpler "plan year." I guess when, before EGTRRA, you looked back 5 years to determine who were your keys (i.e., the keys were participants who at any time during "the plan year or any of the 4 preceding plan years" met one of the status tests), and under pre-EGTRRA Section 416(g) you were also dragging back in all distributions made during the 5 plan years ending on the determination date, it may have made sense for the IRS to want the same 5 year period for both purposes, i.e., the IRS may have been trying to simplify. But if that was the reason for departing from what otherwise seems the very plain statutory language of 416(I)(1), it no longer seems valid, since using balances as of the end of the previous year, and status as of any time in the current year, seems just as easy to do now.

Has anyone else had an issue with this? To anyone's knowledge, has the IRS ever commented on this, formally or informally?

I can't find anything at the moment that has a usable citation.  So, how about a practical analysis? I submit that if an individual terminates early in year X and said individual would be increased pursuant to the top-heavy vesting schedule were the plan determined to be top-heavy it is therefore required that the top-heavy analysis be performed solely with information available at 12/31/X-1.

Does that do it for you?

Mike, thanks. It certainly provides a practical reason for wanting the determination to be based on prior year. Doesn't do it for me in terms of how far the reg departs from plain language of statute, but that's life. Unless the issue makes it up to the textualist U.S. Supreme Court, post-Chevron deference, the reg's rule is probably the one that people do and should follow.

here is one comment from an ASPPA conference (which of course might or might not be valid)

dang it, it is notes from my research from a talk I gave in 2012 so maybe even less reliable! but it was from a Q and A the year before.

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.

2011 ASPPA Conference #47

I've always interpreted the 416 regs as treating the determination of top-heavy status and the determination of who receives the top-heavy minimum separately.  For a calendar year DC plan, the key employees for the top-heavy calculation as of 12/31/2018 are determined based on their status during the 2018 plan year. I think T-12 is clear that is how it works.  For determining who receives the top-heavy minimum for the 2019 plan year, I think the determination is made based on their status during the 2019 plan year. While the regs don't specifically say this, to me, it's the most logical way to do it.  It also matches how the valuations systems I've used handle it.  The top-heavy calculation as of 12/31/2018 is done in the year end valuation for 2018 using 2018 information.  The determination of who receives the top-heavy minimum for 2019 is done in the year end valuation for 2019 using 2019 information. 

The Q&A Tom cited says that IRS person thinks the most reasonable interpretation is that an employee's status during the 2018 plan year is used for both the 12/31/2018 top heavy calculation and determining who receives the top-heavy minimum for 2019.  Does anyone have valuation software that does it this way?

Fortunately, the Q&A points out that there is no clear guidance on this and it doesn't say that interpretation is the only reasonable interpretation, so either method should count as a reasonable good faith interpretation. We've never had an IRS audit where the agent has questioned or had any issues with how we did the top-heavy testing or top-heavy minimum.

FWIW, Relius allows for TH to be allocated to:

All

Exclude current year Keys

Exclude Keys a/o determination date

EOB favors determining key employees on the determination date for all purposes.

Quote

 

Prevailing view: using same testing period for both purposes. Proponents of this view argue that the key employee determination for a plan year should be uniformly determined for both purposes: (1) calculating the top heavy ratio as of the determination date, and (2) identifying the non-key employees who are eligible for the top heavy minimum benefit in the event that the plan is top heavy for the plan year. This approach is clearly simpler from a plan administration standpoint and is the preferred interpretation (and the one IRS seems to support)

IRS sample language for prototypes uses this approach. The IRS’ Listing of Required Modifications for master/prototype plans adopts this approach. The sample language does not provide for a separate testing period to determine which employees are non-key employees for top heavy minimum benefit purposes. In an unpublished general information letter issued in the 1990s by James Holland of the IRS to a taxpayer, the IRS took this approach in determining whether an employee was entitled to a top heavy minimum contribution.

EGTRRA Conference Report indicates agreement with this view. In the explanation of the top heavy provisions in EGTRRA §613, the Conference Report also appears to adopt this view. The explanation does not distinguish between key employee determinations made for the top heavy test and key employee determinations made for the top heavy minimum benefit calculations. Instead, in explaining the law as amended by EGTRRA, the report states that an employee is a key employee for a plan year if he satisfies one of the three key employee tests for the prior plan year (except for the first year of a plan) because the top heavy determination date for a plan year is the last day of the prior plan year.

The plan administrator is charged with following the terms of the plan and, where the terms are ambiguous, is usually charged with the responsibility for interpreting the document. Since the IRS appears to agree with the position described above, most plan administrators interpret ambiguous plan language consistent with that position.

 

3 hours ago, PensionPro said:

EOB favors determining key employees on the determination date for all purposes.

... This approach is clearly simpler from a plan administration standpoint and is the preferred interpretation (and the one IRS seems to support) ...

 

Would someone please explain how it is "simpler from an administration standpoint" to use two different sets of key employees with my 2018 valuation?  The position it is describing says that for purposes of determining who gets the top-heavy minimum for 2018, you determine keys based on their status in 2017.  For the top-heavy ratio calculation that is done with the 2018 valuation as of 12/31/2018 (to determine if the plan is top-heavy for 2019) the keys are determined based on their status in 2018. While in most cases, it might be the same list, there will be times the keys are different from one year to the next.

For those who take the approach described in the EOB and the Q&A, how would you handle the following situation?  On-going calendar year top heavy 401(k) plan with immediate eligibility for all sources.  The 100% owner's spouse is hired 1/1/2018 and works the entire year.  Does the spouse receive the top heavy minimum for 2018? Are the spouse's deferrals for 2018 considered in determining the amount of the 2018 TH minimum?  The definition of key employee starts with "an employee who ... " and the spouse was not an employee during 2017. 

1 hour ago, Kevin C said:

Would someone please explain how it is "simpler from an administration standpoint" to use two different sets of key employees with my 2018 valuation? 

When you work on your 12/31/18 valuation your key employees are determined as of 12/31/17 so you are only determining key employees once.  

When you work on your 12/31/19 valuation your key employees are determined as of 12/31/18 so you are only determining key employees once.

If you want to project 2019 key employees when you are working on 2018 valuation you are skipping ahead to the 2019 valuation so in that case you would redetermine key employees because you are working on the following plan year.

In your example, the spouse is not a key employee as of 12/31/17 but will be as of 12/31/18.

At least that is my perspective.

I think you're all right. I was just puzzled  by the fact that the practical rule, which is stated clearly in !Q&A T-12 of the regs, is only barely supported by the statutory language, if that. But taking the statutory language at face value (i.e., determine TH based on end of prior year balances, but determine keys based on facts in current plan year) would lead to many impracticalities, basically because determining whether you are top-heavy or not for a year would become a dynamic task to be performed daily during the year, and top-heavy status could also be, arguably, dynamic during the year. It just doesn't work.

Good to know that the Conference Report caught the Congressional staff's failure of expression and backfilled for it. If I get time to take a look at the preamble to the regs, there may be some admission there regarding pushing past the bare text of 416(I)(1) to get to a practical result as well.

Thanks for everyone's comments.

47 minutes ago, PensionPro said:

When you work on your 12/31/18 valuation your key employees are determined as of 12/31/17 so you are only determining key employees once.  

When you work on your 12/31/19 valuation your key employees are determined as of 12/31/18 so you are only determining key employees once.

If you want to project 2019 key employees when you are working on 2018 valuation you are skipping ahead to the 2019 valuation so in that case you would redetermine key employees because you are working on the following plan year.

In your example, the spouse is not a key employee as of 12/31/17 but will be as of 12/31/18.

At least that is my perspective.

I don't think we are on the same page.

The 12/31/18 valuation includes both the TH minimum contribution determination for 2018 and the 12/31/18 top heavy test that is used to determine if the plan is top heavy for 2019.  The position taken by the EOB is that these two tasks use key employee determinations as of different years.  Even though the determination is made only once each year, the Key/non key lists from both 2017 and 2018 are used in the course of the 2018 work.

As for the spouse, I think you are saying the spouse is not key for 2018 because the spouse did not meet the definition of a key employee during the 2017 year.  If so, then I have a great deferral only design that will let the couple defer without having to worry about TH minimums.  Owner can't defer.  Spouse is non key for 2018 so defers.  Spouse doesn't work at all in 2019.  Spouse is key for 2019, but it doesn't matter because spouse has zero 2019 comp and deferrals (and the owner didn't defer), so 2019 TH min is zero %.  Spouse works in 2020.  Spouse is non key for 2020 because spouse wasn't an employee in 2019. Spouse defers for 2020. Then, repeat.

This is getting more complicated than I anticipated and I think points other than my original question may have been introduced. For the sake of simplicity and trying to bring this to closure, what I am saying is that the Code and regs are clear that you are TH or not for "a year" (say, Y1) based on whether more than 60% of value as of end of prior year (say, Y0) belongs to keys. The regs are clear that you also determine who are your keys for "the year" (i.e., again, for Y1), based on participant attributes during the prior year (i.e., during Y0). The Code is ambiguous on the latter point, but the regs and, as it turns out, legislative history and practicality, trump the Code's ambiguity on that point.

One doesn't trump ambiguity.  One resolves ambiguity.