Who is counted as an NHCE

I apologize in advance if I am asking a question that has been answered before.  Several hours of searching have failed to help me.

I work at a small startup and no one here knows anything about how any of this works, including myself.  I started us on a 401k plan a couple of years ago and I'm being told that we are failing the ADP test, probably because we only have 6 people and 3 of them are HCEs.

My problem is that the percentages used by the plan to determine this don't make sense to me.  I tried asking them about it, and got a very confusing answer from their support team, having something to do with who is considered eligible to be a NHCE.  After a lot of searching, I finally figured out that they are using the "prior year plan" (I think--nothing else makes sense).  But I still can't figure out who they are counting as an NHCE--does someone who worked for the company last year (2018) who left the company in 2019 count?

What if they joined mid-2018?  Does it matter when?

What if they joined mid-2018 and left in mid-2019?

What if they joined in 2019--do they not count at all because of the prior year thing?  Does it matter when in 2019 they joined?

What if they joined prior to 2018 and then left in 2018?

What if they joined prior to 2018 and then left in 2019?

Any way for me to understand this would be much appreciated.  Does this vary by plan, so I have to ask their unhelpful support team again and can't get an answer here?

These are all questions that should be answered by whoever is administering your plan for you.  The ADP test is not the easiest thing in the world for a non-pension person to understand.  But yes, it is a test that compares the deferrals made (on average) by the HCEs for the year to the deferrals made (on average) by the NHCEs for the year.

And yes, the HCEs for a given year are determined (under one rule) by the compensation earned in the prior year.  If it is high enough in the prior year, they are an HCE for the current year.  The other criteria is ownership, which can also make someone and HCE and that is actually regardless of how high their income actually is.

What you need to do is ask your administration folks for an actual copy of the ADP test; it will show you who is in the test for both HCEs and NHCEs and the allocations to each that are being tested and the math that shows the results and why you did, or (in this case) did not pass. That test printout is something that they should absolutely be able to give you; we all do that test for our clients and our software spits out the results with all the necessary info to show the failure and, often, what the correction is that is required to make it pass.

To answer all the questions you posed requires a detailed tutorial on this issue, and that would be both long and complicated and really unnecessary. You need to know only why YOU didn't pass (unless you are deciding to go into the plan administration business, in which case you will need a few years of study under someone who already knows all the rules!).  

Best of luck.

If your current provider will not/cannot answer these questions then I strongly suggest seeking an provider who's willing to take the time to explain it. If you started with a "Budget-friendly" TPA then you're now seeing how they keep their costs down. 

Good advice in the 2 posts above.

Short answer is if you own or are deemed to own more than 5% of the company in current or prior year you are an HCE for the current year. If you made more than a certain dollar amount in the prior year you are an HCE for the current year.  There is an election you can make that can limit the number of HCEs due to pay to the top 20% of your employees. If you are eligible for the plan for any part of the year you are in the test.

There are a host of elections and testing options that can make this much more complicated because the IRS never likes anything to be easy so that's why you hire a TPA firm to do this for you. They should be able to explain most of the basics to you but if you want in depth explanations about how the tax code works be prepared to pay for their time.