How do I know if I am a Highly Compensated Employee?

Question

Does my employer inform me whether or not I am a highly compensated employee? If not, how do I find out, other than getting money refunded at the end of year if my company was over their 401k HCE contribution limit? Do I need to just email Payroll and ask?

I know there are 3 criteria: own more than 5% of the company, income over a certain limit from that company, or within top 20% of earners.

I definitely don’t meet the 5% metric. I am under the income limit when base salary is considered, but over it when you add in stock compensation. I have no idea if I’m in the top 20% of earners. It seems like the IRS leaves it up to my employer to make the final determination?

I’m making changes to my 401k and FSA contributions, and I want to know ahead of time if I will be subject to the lower contribution limits for the Dependent Care FSA. In the past, I have not contributed enough to need to ask or know this.

Answer 1

I'm answering my own question based on this question's activity, my own research, and discussions with my financial advisor. 0xFEE1DEAD's answer goes a long way, but it contains a lot of information that isn't relevant to an employee.

You can't know for sure if you are a Highly Compensated Employee. It's a company-specific thing rather than an IRS blanket rule. But it doesn't really matter, because this distinction isn't meant for you. It's a way to help your employer manage their benefit plans to make sure the plans don't favor employees that have higher income. Make your elections as you see fit and as your employer allows.

For your 401(k), it's your employer's responsibility to make sure they comply with the nondiscrimination rules for HCEs. If you are an HCE and they fall afoul of the rules, you may get some money returned to you at the end of the year, but that shouldn't stop you from contributing up to the maximum allowed amount if you choose to do so.

For your Health and Dependent Care FSAs, restricting contributions for HCEs seems to be a company-specific rule rather than a hard-and-fast rule set by the IRS. You can make your elections as your benefit enrollment system allows you to, and let your company limit your contributions if necessary. Hopefully, your company has set up their benefits system so that you can't elect to contribute more than you should be allowed to.

Even if your income is above the threshold to be considered an HCE, it's up to your employer whether or not they choose to classify only the top 20% of employees by compensation as HCEs, based on how they want to manage the fairness of their plan offerings. They don't generally share this information with you. But if you have questions on how your company handles this, you can reach out to your company's benefits and/or payroll administrator.

Answer 2

As far as I'm aware, your company doesn't usually tell you whether you're a HCE. You should change your elections as you see fit. If this causes the plan to fail the non-discrimination test, it's up to the company to take corrective action.

Nondiscrimination

Realizing 401(k) plan tax benefits requires that plans provide substantive benefits for rank-and-file employees, not only for business owners and managers. These requirements are referred to as nondiscrimination rules and cover the level of plan benefits for rank-and-file employees compared to owners/managers.

Traditional 401(k) plans are subject to annual testing to ensure that the amount of contributions made on behalf of rank-and-file employees is proportional to contributions made on behalf of owners and managers. Safe harbor 401(k) plans and SIMPLE 401(k) plans are not subject to annual nondiscrimination testing.

https://www.irs.gov/retirement-plans/operating-a-401k-plan#Nondiscrimination

Highly Compensated Employee - An individual who:

• Owned more than 5% of the interest in the business at any time during the year or the preceding year, regardless of how much compensation that person earned or received, or
• For the preceding year, received compensation from the business of more than $125,000 (if the preceding year is 2019 and $130,000 if the preceding year is 2020 or 2021), and, if the employer so chooses, was in the top 20% of employees when ranked by compensation.

https://www.irs.gov/retirement-plans/plan-participant-employee/definitions

401(k) Plan Fix-It Guide - The plan failed the 401(k) ADP and ACP nondiscrimination tests

Plan sponsors must test traditional 401(k) plans each year to ensure that the contributions made by and for rank-and-file employees (nonhighly compensated employees (NHCE)) are proportional to contributions made for owners and managers (highly compensated employees (HCE)). As the NHCEs save more for retirement, the rules allow HCEs to defer more. These nondiscrimination tests for 401(k) plans are called the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests.

[...]

There are two different methods to correct ADP and ACP mistakes beyond the 12-month period. Both require the employer to make a qualified nonelective contribution to the plan for NHCEs. A qualified nonelective employer contribution (QNEC) is an employer contribution that is always 100% vested and subject to the same distribution restrictions as elective deferrals.

• Method 1 – Revenue Procedure 2019-19, Appendix A, Section .03: Determine the amount necessary to raise the ADP or ACP of the NHCEs to the percentage needed to pass the tests. Make QNECs for the NHCEs to the extent necessary to pass the tests. You must generally make QNECs for all eligible NHCEs. These contributions must be the same percentage for each participant.
• Method 2 – one-to-one method under Revenue Procedure 2019-19, Appendix B, Section 2.0: Excess contributions (adjusted for earnings) are assigned and distributed to the HCEs. You should notify the employee that the excess contribution is not eligible for favorable tax-free rollover. The refunded excess contribution is taxable to the HCE in the year of distribution. You should report the refunded excess on a Form 1099-R. That same dollar amount is contributed as a QNEC to the plan and allocated based on compensation to all eligible NHCEs. Matching contributions (and earnings) related to the excess contributions distributed to the HCEs are forfeited. If the Plan provides for catch-up contributions, the refund may be recharacterized as a catch-up contribution (up to the catch-up limit) provided: The affected HCE participant is age 50 or older, and The participant has not already used up the catch-up limit for the year.

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Update to address the Health/Dependent Care FSA part:

Plans that favor highly compensated employees. If your plan favors highly compensated employees as to eligibility to participate, contributions, or benefits, you must include in their wages the value of taxable benefits they could have selected. A plan you maintain under a collective bargaining agreement doesn't favor highly compensated employees. A highly compensated employee for this purpose is any of the following employees.

1. An officer.
2. A shareholder who owns more than 5% of the voting power or value of all classes of the employer's stock.
3. An employee who is highly compensated based on the facts and circumstances.
4. A spouse or dependent of a person described in (1), (2), or (3).

[...]

Exception for highly compensated employees. You can't exclude dependent care assistance from the wages of a highly compensated employee unless the benefits provided under the program don't favor highly compensated employees and the program meets the requirements described in section 129(d) of the Internal Revenue Code. For this exclusion, a highly compensated employee for 2021 is an employee who meets either of the following tests.

1. The employee was a 5% owner at any time during the year or the preceding year. The employee received more than $130,000 in pay for the preceding year.
2. You can choose to ignore test (2) if the employee wasn't also in the top 20% of employees when ranked by pay for the preceding year. Form W-2. Report the value of all dependent care assistance you provide to an employee under a dependent care assistance program in box 10 of the employee's Form W-2. Include any amounts you can't exclude from the employee's wages in boxes 1, 3, and 5. Report in box 10 both the nontaxable portion of assistance (up to $5,000) and any assistance above that amount that is taxable to the employee.

https://www.irs.gov/publications/p15b#en_US_2021_publink1000193665