If an individual owns 3% of the company's stock outright and another 8% of the company stock as a participant in the company's 401(k)/profit sharing plan, is the individual considered a "greater than 5% owner" for purposes of the definitions of "highly compensated employee" (HCE) and "key employee"?
Rev. 07/08/05, E-mail Alert 2005-13

The individual is not a more than 5% owner because the ownership of company stock through the 401(k)/profit sharing plan is not attributed to the individual. It is owned by the plan. Thus, any company stock in a qualified retirement plan (any plan qualified under Internal Revenue Code Section 401(a)) is not considered owned by the individual.

So, in this example, the 8% owned by the participant in the plan is not counted. Therefore, the individual is not a more than 5% owner, and thus is not an HCE or a key employee (see IRC Section 318(a)(2)(B)(i)). The above rule applies only to ownership attribution, though. Such an employee could still qualify as an HCE, depending on the employee’s compensation.