Chapter 4: Highly Compensated Employees

Question 1

What does HCE stand for?

Answer 1

Highly compensated employee.

Question 2

What does NHCE stand for?

Answer 2

Nonhighly compensated employee.

Question 3

The identification of HCEs is necessary for determining whether the minimum coverage requirements of IRC §410(b) have been satisfied.

Answer 3

True.

Question 4

The determination year for identifying HCEs is the 12-month period immediately preceding the plan year.

Answer 4

False. The determination year for HCE purposes is the current plan year.

Question 5

The identification of HCEs is necessary for determining whether the nondiscrimination requirements of IRC §401(a)(4) have been satisfied.

Answer 5

True.

Question 6

The brother of a 5 percent owner is an HCE.

Answer 6

False. Stock ownership is attributed from parents, spouses and lineal descendants. Attribution does not extend to siblings.

Question 7

Absent a top-paid group election, all employees who earn more than $80,000, as indexed, in the lookback year are considered HCEs.

Answer 7

True.

Question 8

Employees who have not attained age 25 may be excluded from the top-paid group determination.

Answer 8

False. Employees who have not attained age 21 may be excluded from the top-paid group determination.

Question 9

A 5 percent owner for purposes of determining who is an HCE is an individual who owns more than 5 percent of the business.

Answer 9

True.

Question 10

Employees who have been employed for nine months may be excluded from the top-paid group determination.

Answer 10

False. Employees who have been employed less than six months may be excluded from the top-paid group determination.

Question 11

For the 2012 calendar year, only employees earning more than $110,000 in 2011 will be considered HCEs.

Answer 11

False. For the 2012 calendar year, the lookback year is 2011. The compensation limit in 2011 is $110,000. Also, employees who are 5 percent owners in either 2011 or 2012 are considered HCEs regardless of their compensation.

Question 12

Jim owns 100 percent of ABC Company. Jim’s daughter, Anne, and her husband, Mark, are employees of ABC Company. Mark is considered an HCE because he is a 5 percent owner due to attribution.

Answer 12

False. Anne is considered owning 100 percent of ABC Company due to attribution from her father. This stock is not attributed again to her spouse, because that would
be double attribution. However, Mark could be an HCE under the compensation test.

Question 13

All of the following statements regarding HCE determination are TRUE, EXCEPT:

A. An employee’s compensation for the current plan year has no bearing on the employee’s HCE status for that year.

B. The lookback year is generally the 12-month period preceding the determination year.

C. The 5 percent owner test applies to the determination year and the lookback year.

D. The compensation test applies to the lookback year only.

E. An employee must satisfy the 5 percent owner test and the compensation test to be considered an HCE.

Answer 13

E. An employee is considered an HCE if he or she or she satisfies either the 5 percent owner test or the compensation test. The employee need not satisfy both
tests to be an HCE.

Question 14

Which of the following statements regarding HCE determination is/are TRUE?

I. The IRC §1563 attribution rules apply when determining HCEs.

II. An employee who owns 5 percent of the employer fails to satisfy the 5 percent owner test.

III. An individual who owns 10 percent of a corporation has an ownership interest via attribution in other entities owned by that corporation.

A. I only

B. II only

C. I and III only

D. II and III only

E. I, II and III

Answer 14

D. The IRC §318 attribution rules apply when determining HCEs.

Note: An employee who owns 5 percent of the employer fails to satisfy the 5 percent owner test because the 5 percent owner test is only satisfied if the employee owns more than 5 percent of the employer at any time during the determination year or the lookback year.

Question 15

All of the following are HCEs, EXCEPT:

A. A sole proprietor

B. The grandson of a 50 percent owner

C. The spouse of a 10 percent owner

D. The grandfather of a 30 percent owner

E. The daughter of a 75 percent owner

Answer 15

B. For HCE determination, there is attribution from grandchildren to grandparents, but there is no attribution from grandparents to grandchildren.

Question 16

All of the following statements regarding the calendar year data election are TRUE, EXCEPT:

A. It is applicable when determining the lookback year for the 5 percent owner test.

B. It is applicable when determining the lookback year for the compensation test.

C. It may be made only for a noncalendar year plan.

D. It must be reflected in the document if a plan contains an HCE definition.

E. It may be made operationally if a plan document does not include an HCE definition.

Answer 16

A. The calendar year data election applies only to determine the lookback year for the compensation test and does not apply to determine the HCEs under the 5
percent owner test.

Question 17

Based on the following information, determine which of the following employees is/are HCEs for 2012:

• The company employees 100 people.
• The company sponsors a calendar year profit sharing plan.
• Employee A is married to Employee D.
• The employer has not made the top-paid group election.

Employee Ownership 2011Comp 2012 Comp
A 60% $150,000 $180,000
B 30% $97,000 $97,000
C 5% $87,000 $116,000
D 0% $85,000 $85,000
E 5% $50,000 $55,000

A. Employee A only

B. Employees A and B only

C. Employees A, B and D only

D. Employees A, B, C and E only

E. Employees A, B, C, D and E

Answer 17

C. To satisfy the 5 percent ownership test, an employee would need to own more than 5 percent of the business in either the prior year (2011) or the current year (2012). Employees A and B each own more than 5 percent. In addition, Employee D is considered to own more than 5 percent due to attribution from his or her spouse, Employee A. Employees C and E own exactly 5 percent and do not meet the 5 percent owner test.
To satisfy the compensation test, an employee must earn more than $110,000 in the lookback year (2011). Only Employee A satisfies this requirement.

Question 18

Based on the following information, determine which of the following employees is/are HCEs for 2012:

• Employee A is married to Employee B .
• Employee C’s ownership was sold to Employee A on the last day of the 2011 plan year.
• Employee D is the brother of Employee A.
• Employee E is the child of Employees A and B.

Emp 2011 Own 2012 Own 2011 Comp 2012 Comp
A 90% 100% $75,000 $90,000
B 0% 0% $30,000 $35,000
C 10% 0% $60,000 $50,000
D 0% 0% $40,000 $45,000
E 0% 0% $15,000 $20,000

A. Employee A only

B. Employees A and Conly

C. Employees A, B and E only

D. Employees A, B, C and E only

E. Employees A, B, C, D and E

Answer 18

D. To satisfy the 5 percent ownership test, an employee must own more than 5 percent of the business in either the prior year (2011) or the current year (2012). Employees A owns more than 5 percent in 2011 and 2012. Employee B is considered to own more than 5 percent due to attribution from his or her spouse, Employee A. Employees C owned more than 5 percent in 2011. Employee E is considered to own more than 5 percent due to attribution from his or her parent, Employee A. There is no ownership attributed to siblings so Employee D has no ownership interest.

To satisfy the compensation test, an employee must earn more than $110,000 in the lookback year (2011). None of the employees satisfied this requirement.

Question 19

All of the following statements regarding the top-paid group election are TRUE, EXCEPT:

A. Employees who have not completed six months of service by the end of the lookback year may be excluded.

B. The plan sponsor is not required to use the top-paid group election to limit the number of HCEs.

C. Employees who are more than 5 percent owners may be excluded.

D. Employees who have not attained age 21 by the end of the lookback year may be excluded.

E. The top-paid group election must be applied consistently to all compliance tests using HCE determinations.

Answer 19

C. When determining HCEs using the top-paid group election, employees may not be excluded from consideration simply because they are 5 percent owners.

Question 20

Based on the following information, determine the minimum number of employees that must be included in the top-paid group for determining HCEs:
No employee in the table below is counted more than once.

Total employees - 500

More than 5% owners - 5

Employees under age 21 - 15

Employees who have not completed six months of service - 75

Seasonal employees who work two months per year - 10

Part -time employees who work approximately 20 hours per week - 20
Full Time non-owner employees over age 21 - 375

A.75

B. 80

C. 84

D.99

E. 100

Answer 20

B. Employees under age 21, employees who have not completed six months of service and employees who normally work less than six months per year may be
excluded. Therefore, the top-paid group must include at least 80 employees (500 - 15 - 75 - 10 =400) x .20.

Question 21

Which of the following statements regarding the calendar year data election is/are TRUE?
I. The election applies to determine the lookback year for the 5 percent owner test.

II. The election applies to determine the lookback year for the compensation test.

III. The election must be reflected in the document if the plan contains an HCE definition.

A. I only

B. II only

C. I and III only

D. II and III only

E. I, II and III

Answer 21

D. A calendar year data election affects the calculation of the lookback year. The election may be made only for a noncalendar year plan. If the election is made,
the lookback year is the calendar year that begins in the 12-month period preceding the current plan year.

The calendar year data election applies only to determine the lookback year for the compensation test and does not apply to determine the HCEs under the 5 percent owner test. The calendar year data election must be reflected in the document only if a plan otherwise contains an HCE definition. If a plan does not Include a definition of HCE, the calendar year data election may be made operationally.

Question 22

Which of the following employees is/are excludable under the top-paid group limitation?

I. Employees who normally work fewer than 17½ hours per week

II. Employees who are under age 21

III. Employees who normally work fewer than six months per year

A. II only

B. III only

C. I and II only

D. II and III only

E. I, II and III

Answer 22

E. All of these employees may be excluded when determining the top-paid group.

Question 23

All of the following statements regarding HCEs within the meaning of IRC §414(q) are TRUE, EXCEPT:

A. An employee must satisfy both the ownership test and the compensation test to be considered an HCE.

B. The indexed dollar amount used in the compensation test is based on the calendar year in which the lookback year begins.

C. Compensation is not considered when applying the ownership test.

D. An employee’s ownership in the current plan year is considered when determining HCE status.

E. An employee’s compensation in the current plan year is not considered when determining HCE status.

Answer 23

A. An employee is considered an HCE if they satisfy either the ownership test or the compensation test - the employee need not satisfy both.

The 5 percent owner test is satisfied if the employee owns more than 5 percent of the employer (or a related employer) at any time during the current plan year or during the lookback year. An employee is an HCE under the compensation test if the employee’s compensation for the lookback year is more than a
prescribed dollar amount ($115,000 for 2012). Because compensation is determined for the lookback year, the employee’s compensation for the current plan year has no bearing on the employee’s HCE status for that year.

Question 24

Based on the following information, determine the HCEs for 2012:

• Employees A and B are married.
• The top-paid group election is not made.

Emp 2011Comp 2011Own 2012Comp 2012Own
A $250,000 75% $275,000 75%
B $50,000 0% $55,000 0%
C $125,000 0% $130,000 15%
D $60,000 25% $85,000 10%
E $80,000 0% $115,000 0%

A. A, B and D only

B. A, C and D only

C. A, B, C and D only

D. A, C, D and E only

E. A, B, C, D and E

Answer 24

C. An employee is an HCE in 2012 if they are a more than 5% owner in 2011 or 2012, or if they earn more than $110,000 in 2011. Employees A, B, C and D
satisfy the ownership requirements and Employee C also satisfies the compensation requirement. Note, while Employee B is not a direct owner, Employee B is attributed ownership through marriage to Employee A.

Question 25

All of the following statements regarding the top-paid group election are TRUE, EXCEPT:

A. The top-paid group is not used in the determination of key employees.

B. An employee may be considered an HCE if in the top 20 percent of employees when ranked by compensation in the lookback year.

C. If an employer makes a top-paid group election in one plan it must do so in all other plans that begin in the same calendar year.

D. An employee who is a more than 5 percent owner may be considered an NHCE if the employer makes the top-paid group election.

E. The decision to use the top-paid group election in determining HCEs, if made, must be included in a prototype plan document.

Answer 25

D. The top-paid group election applies only to the compensation test and does not
affect whether an employee is an HCE under the 5 percent owner test. When making the top-paid group election, employees who are not HCEs because of the
top-paid group determination are included in all coverage and nondiscrimination tests as NHCEs, unless they meet the 5 percent owner test.

The top-paid group election may only be used for HCE determination purposes and may not be used in the determination of key employees.