IRS Releases Issue Snapshot Regarding Identification of HCEs in Short or Initial Plan Years

On April 21, 2017, the IRS posted an Issue Snapshot containing a summary of the rules for identifying highly compensated employees (HCEs) for retirement plan purposes in a plan’s initial plan year or in the case of a short plan year. The summary confirms that there are two tests for determining if an employee is a HCE: an ownership test and a compensation test. If the employee satisfies either of the two tests, then they will be an HCE. The summary contains eight examples that apply the two tests under various scenarios.

Under the ownership test, an employee will be found to be an HCE if he is a 5 percent owner at any time during the determination year (the current plan year) or the look-back year (12-month period immediately preceding the determination year). Under the compensation test, an employee will be found to be an HCE if he received compensation from the employer in excess of a certain dollar threshold during the look-back year ($120,000 for 2016).

There are two design alternatives under the compensation test. Under the first alternative, an employee will be an HCE if he received compensation in excess of a certain threshold (as outlined above) AND is in the top 20 percent of employees ranked by compensation for the look-back year. This additional criterion is known as the top-paid group election. The employer may make the election of this alternative for any year. However, once the election is made, it applies until it is revoked. Also under the compensation test, an employer with a non-calendar year plan can elect to have the look-back year be the calendar year that begins with or within the 12-month period immediately preceding the determination year. These alternative elections are not available under the ownership test.

Employers who sponsor retirement plans should refer to this and other Issue Snapshots as a helpful resource, but please note that Issue Snapshots are not to be used as precedent. They are not official pronouncements of law or directives. Issue Snapshots provide an overview of an issue but may not contain a comprehensive discussion of the law.

IRS Issue Snapshot »