The concept of a "key employee" is crucial in applying the rules for top-heavy plans and for several other nondiscrimination requirements, such as the concentration test applicable to Cafeteria Plans.
Generally, key employees include:
- Five-percent owners;
- One-percent owners with compensation of more than $150,000; and
- Officers with annual compensation of more than $160,000 (as of 2009 -- $150,000 for 2008).
Code Section 416(i).
No more than 50 individuals (or, if lesser, the greater of 3 individuals or 10 percent of the emplyoees) are considered officers. The compensation threshold for officers is adjusted annually for inflation. See Dollar Limitations.
Treas. Reg. Section 1.416-1, Q&A 12 is the only official IRS guidance on the definition of key employee.
T–12 Q. For purposes of determining whether a plan is top-heavy for a plan year, who is a key employee?
A. Under section 416(i)(1), a key employee is any employee (including any deceased employee) who at any time during the plan year containing the determination date for the plan year in question or the four preceding plan years (including plan years before 1984) is:
1. An officer of the employer having annual compensation from the employer for a plan year greater than 150 percent of the dollar limitation in effect under section 415(c)(1)(A) for the calendar year in which such plan year ends (see Questions and Answers T–13, T–14, and T–15),
2. One of the ten employees having annual compensation from the employer for a plan year greater than the dollar limitation in effect under section 415(c)(1)(A) for the calendar year in which such plan year ends and owning (or considered as owning within the meaning of section 318) both more than a1/2percent interest and the largest interests in the employer (see Question and Answer T–19),
3. A 5-percent owner of the employer, or
4. A 1-percent owner of the employer having annual compensation from the employer for a plan year more than $150,000 (see Questions and Answers T–16 and T–21).
An individual may be considered a key employee in a plan year for more than one reason. For example, an individual may be both an officer and one of the ten largest owners. However, in testing whether a plan or group is top-heavy, an individual's accrued benefit is counted only once. The terms key employee, former key employee, and non-key employee include the beneficiaries of such individuals. This Question and Answer is illustrated by the following examples:
Example 1. An employer maintains a calendar-year plan. An individual who was an employee of the employer and a 5-percent owner of the employer in 1986 was neither an employee nor an owner in 1987 or thereafter. Even though the individual is no longer an employee or owner of the employer, the individual would be treated as a key employee for purposes of determining whether the plan is top-heavy for each plan year through the 1991 plan year. However, for purposes of determining whether the plan is top-heavy for the 1992 plan year and for subsequent plan years, the individual would be treated as a former key employee.
Example 2. The facts are the same as in example (1), except that the individual died in early 1987 and his total benefit under the plan was distributed to his beneficiary in 1987. Such distribution would be treated as the accrued benefit of the individual for each year through the 1991 plan year. However, such individual would be treated as a former key employee for purposes of determining whether the plan is top-heavy for the 1992 plan year and for subsequent plan years. The conclusions are not affected by whether the beneficiary of the individual is a non-key employee or a key employee of the employer.