Highly Compensated Employees (HCEs) are individuals who meet specific criteria set by the Internal Revenue Service (IRS) in the United States. An HCE typically holds a significant ownership stake in the company and receives compensation that exceeds a federally predetermined threshold.
Ownership Criteria
An HCE must own at least 5% of the company during the current year or the previous year. This ownership can be direct or indirect, encompassing shares, stock options, or voting power.
Compensation Requirements
To qualify as an HCE, the individual must also earn more than a specific compensation limit set by federal regulations. This limit is adjusted annually for inflation and published by the IRS.
Types of Highly Compensated Employees
5% Owners
Individuals who own more than 5% of the business at any time during the year, regardless of their compensation, are automatically considered HCEs.
Top Earners
Employees who do not meet the ownership criterion may still be classified as HCEs if their compensation exceeds the annual threshold set by the IRS.
Family Attribution Rules
Ownership rules also extend to family members. For example, the ownership percentage of an employee may include shares owned by their spouse, children, and parents, potentially qualifying the employee as an HCE through family attribution.
Special Considerations
Calculation of Compensation
Compensation for the HCE classification usually includes wages, salaries, bonuses, and other types of employment income as determined by the IRS.
Impact on Retirement Plans
HCEs often face different restrictions and testing criteria for participation in company-sponsored retirement plans, such as 401(k) plans. The intention is to prevent discriminatory practices that favor higher-paid employees.
Examples
Example 1: Ownership-Based HCE
Alice owns 7% of a mid-sized tech company but earns $90,000 annually. Despite her earnings being below the federal limit, Alice is considered an HCE due to her ownership stake.
Example 2: Compensation-Based HCE
Bob is a manager at a retail company with earnings of $200,000, surpassing the compensation threshold. Even without any ownership stake, Bob is classified as an HCE because of his earnings.
Historical Context
The HCE designation and related rules were introduced to ensure equity in employee benefit plans and prevent excessive benefits from being directed only to top-paid employees. The IRS periodically adjusts the compensation limits to align with economic conditions and inflation.
Applicability
HCEs are relevant in various contexts, including compliance with the Employee Retirement Income Security Act (ERISA) and adherence to nondiscrimination testing in retirement plans to maintain their qualified status.
Comparison with Key Employees
Key employees also play a significant role in nondiscrimination testing but differ as they include officers, shareholders, and employees with significant compensation. Unlike HCEs, key employees are identified through a different set of criteria.
Related Terms
- Non-Highly Compensated Employees (NHCEs): Employees who do not meet the HCE criteria.
- Nondiscrimination testing: Ensures fairness in benefit plans by comparing benefits received by HCEs and NHCEs.
- ERISA: A federal law that sets minimum standards for retirement and health benefit plans in private industry.
Frequently Asked Questions
What is the current compensation limit for HCEs?
The IRS revises the compensation limit annually, so one should check the most current figure from the IRS website or relevant federal publications.
Why is the HCE classification important?
The classification ensures regulatory compliance and helps maintain the fairness and qualified status of company retirement plans.
Does the HCE status affect eligibility for other benefits?
HCE status predominantly affects retirement plan contributions and testing but may also influence eligibility for certain executive benefits.
References
- Internal Revenue Service. “Highly Compensated Employee.” IRS.gov.
- U.S. Department of Labor. “Employee Retirement Income Security Act (ERISA).”
Summary
A Highly Compensated Employee (HCE) is characterized by ownership of at least 5% of the company or compensation surpassing a federal threshold. Understanding the criteria and implications associated with HCE status is crucial for compliance with various regulations and ensuring equitable benefit distributions amongst employees.
