IRS Compliance Testing: Top-Heavy Test

IRS Compliance Testing: Top-Heavy Test

Valuable Information on 401ks, Pensions, ESOPs, Form 5500 Preparation + More

In order to ensure that employee benefit plans do not violate certain standards that the DOL and IRS believe are important, plans are subjected to annual compliance tests. These tests are designed to ensure that the amount employees are deferring is within certain maximum limits and that plans are not operating in a manner that discriminates against certain classes of employees. The most common compliance testing performed by defined benefit plans on an annual basis are the ADP and ACP Tests, the Top-Heavy Test, the 415 limits testing and the multiple use test.

The ADP and ACP Tests were discussed in a previous blog and we will cover the 415 limits testing and multiple use test in future articles. Following we will address the Top-Heavy Test.

All qualified plans must satisfy the top heavy requirements of IRC 416. To determine if a plan is top-heavy, the key employees must be identified. A plan is considered to be top-heavy when the combined plan assets of the key employees total 60% or more of the plan’s total assets. An employee is considered to be a key employee if, at any time during the plan year, he or she was:

• An officer of the company with annual compensation of $130,000 or more.
• One who owns greater than 5% of the business or a family member of a %5 owner.
• One who owns greater than 1% of the business and earns more than $150,000 a year.

In order for an officer to be considered a key employee, the officer must be an officer-in-fact and not just an officer-in-title. The number of officers considered to be key employees is limited to the greater of three or 10% of the employees and, regardless of the number of employees, no more than 50 officers are considered to be key employees. A 5% owner is considered to be an employee who owns more than a 5% interest in a corporate employer, or more than 5% of the employer’s outstanding stock or combined voting power.

When a plan is determined to be top-heavy, a minimum mandatory contribution is required to be made by the employer. The minimum mandatory contribution is made by the employer on behalf of all non-key employees still employed as of the last day of the plan year. Generally, the required minimum mandatory contribution is 3% of non-key employees’ salaries; however, if key employees are contributing less than 3% but more than 0%, a contribution equal to the highest contribution percentage of any key employee must be made to each eligible non key employee.

Joe Goodmiller