Repeal of the family aggregation rules in defining HCEs in a qualified plan.

• Author: Wasserstrum, David
• Position: Highly compensated employees

The definition of a highly compensated employee (HCE) is one of the fundamental concepts inherent in qualified retirement plans governed by Sec. 401(a). The pervasive theme of the qualification requirements is that a plan may not discriminate in favor of HCEs. Prior to the enactment of the Tax Reform Act of 1986 (TRA '86), there was no statutory definition of HCE. The TRA '86 enacted Sec. 414(q), which defined HCEs to mean generally any employee who, during the year or the preceding year:

* Was at any time a 5% owner;

* Received compensation from an employer in excess of $75,000;

* Received compensation from an employer in excess of $50,000 and was in the top 20% of employees when ranked on the basis of compensation for such year; or

* Was at any time an officer and received compensation greater than 50% of the maximum annual defined benefit plan benefit limit.

(The $75,000 and $50,000 amounts have been adjusted for cost-of-living increases.)

The Small Business Job Protection Act of 1996 (SBJPA) amended the definition of HCE to mean an employee who was a 5% owner during the current or preceding year or an employee who earned in excess of $80,000 during the preceding year. A top 20% group election is available as to the second definition.

The definition of 5% owner in Sec. 414(q)(2) includes direct or indirect ownership through family attribution under Sec. 318. Under Sec. 318, an individual is considered to own any stock owned directly or indirectly by his spouse, children. grandchildren or parents. As a result, an employee who is the spouse, child, parent or grandparent ("family member") of an individual with a 5% interest in the employer is treated as an HCE. regardless of the family member's compensation level.

Prior to the SBJPA, Sec. 414(q)(6) included the family aggregation rules. Members of the family of either a 5% owner or of an HCE in the top ten HCEs were also treated as HCEs. Such family aggregation group members were treated as a single HCE. In addition, any compensation paid to a family-aggregated employee was treated as if it were paid to the HCE. For purposes of aggregation under Sec. 414(q)(6),"family" includes an employee's spouse, lineal ascendants and descendants, and their spouses. The SBJPA repealed the family aggregation rules for plan years beginning in 1997.

The family aggregation rules impose a variety of constraints on family-aggregated plan participants. First, there is a dollar limit on the amount of...