Even when using the “top-paid group election” to determine highly compensated employees, the 5% owners rule must be considered since 5% owners may not be in the top 20% group. How can these rules be reconciled?
Rev. 10/09/09; E-mail Alert 2009-16; Rev. 12/11/07, Rev. 07/09/04, E-mail Alert 2004-14 |
The highly compensated group consists of individuals who own more than 5% of the business entity in either the current plan or the prior year, and employees who received compensation in excess of $80,000 (as indexed—$110,000 in 2009) in the prior plan year. The top-paid group election permits the employer to limit the highly paid group to owners and the top 20% of employees when ranked by compensation.
An employee is a member of the top-paid group if he or she is among the highest paid 20% of all employees. |
For purposes of applying the 20% rule (i.e. determining the size of the group, but not who is actually in the group), the following employees are excluded:
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Employees with less than 6 months of service; |
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Part-time employees (less than 17½ hours per week); |
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Seasonal employees who normally work less than 6 months during the year; |
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Employees under the age of 21; |
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Nonresident aliens without U.S. source income; and |
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Collective bargaining agreement employees, if they represent 90% or more of all employees and none of the collective bargaining employees are benefiting under the plan. |
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The employer may adopt any tie-breaking rules it desires where two or more employees have the same compensation. Such rules must be reasonable, nondiscriminatory and uniformly and consistently applied. |
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EXAMPLE 1 |
| Law Firm Employee Data for 2009 |
| 20 Eligible Employees in Firm |
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Prior Year Compensation |
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HC |
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HC/Top 20% |
1. |
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Senior Partner |
$300,000 |
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X |
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X |
2. |
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Senior Partner |
$250,000 |
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X |
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X |
3. |
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Partner |
$200,000 |
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X |
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X |
4. |
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Partner |
$180,000 |
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X |
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X |
5. |
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Associate |
$130,000 |
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X |
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6. |
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Associate |
$120,000 |
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X |
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7. |
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Paralegal |
$101,000 |
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through 20 are Staff |
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| Total HCEs |
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6 |
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4 |
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Top 20% calculation: Total eligible employees 20 x 20% = 4 (Total HCEs)
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EXAMPLE 2
Using the same demographic as above, with a change in the status of employee 7, who, in this example, has a 6% ownership in the firm (possibly due to family attribution).
Using the HCE definition without the top-paid group election, there would be 7 HCEs.
Using the top-paid group election, we would count the top 4 compensated employees as we did in example 1. However, in addition, we would also have to count the 5% owner as an HCE, and thus, have a total of 5 HCEs. |
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Where is the top-paid group election made in our defined contribution EGTRRA prototype document?
Under Section III (Definitions) of the McKay Hochman EGTRRA defined contribution adoption agreement the top-paid group election is under the definition of Highly Compensated Employee. Under the GUST adoption agreement an employer had the option of selecting the top-paid group election for determining HCEs. In addition to that option being available for the employer to select on the EGTRRA adoption agreement, if the employer makes no selection, the EGTRRA plan defaults to using the top-paid group election.
Is there any reason why the default should not be used for all employer plans?
When doing discrimination testing in a qualified plan, the issue arises as to which participants are and are not HCEs. That answer may change based on whether or not the top-paid group election is made. Therefore, the top-paid group election could become an issue in a plan when limiting the number of HCEs could cause an unintended problem. For example, in a cross-tested plan where the allocation groups were determined based on using each HCE in a separate group - if the plan default to the top-paid group election causes some of the HCEs to be treated as NHCEs. The employer’s allocation to individuals that are no longer HCEs due to this election could be problematic. There could be too many rate groups for the NHCEs and the rate groups could be discriminatory.
When implementing a plan amendment to change the top-paid group election care should be taken to assure that anti-cutback issues do not arise. In some situations the amendment may need to be made on a prospective basis rather than retroactive.
Bill Grossman, ERPA, QPA
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© 2012, McKay Hochman Co., Inc. All rights reserved.
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