HCE Options [Highly Compensated Employee]

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bUU
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HCE Options [Highly Compensated Employee]

Post by bUU »

I've asked similar questions in the past, but the answers didn't clarify things for me, so please answer very simply, as if the reader (me) is a dummy. :happy

From IRS Publication 560:
Highly compensated employee. A highly compensated employee is an individual who: ... For the preceding year, received compensation from you of more than $110,000 (if the preceding year is 2011, $115,000 if the preceding year is 2012 or 2013) and, if you so choose, was in the top 20% of employees when ranked by compensation.
What does "preceding year" mean?

This resource, and several others, indicate one interpretation:
Note: A person hired during a plan year who is not an owner cannot be an HCE for their first year of employment because they did not make more than $115,000 in the prior year. For example, suppose you hire someone on 1/5/2013 and pay them $400,000 for 2013, but they are not a greater than 5% shareholder. That person would still NOT be in the HCE group for 2013.
http://www.abgil.com/employee_benefits_plans

Essentially, that reference seems to imply that, no matter what, that first year your salary goes over the limit your contributions are safe and won't be taxed. My own read of the publication made me think that the "preceding year" thing was simply referring to the fact that in April 2014 you pay taxes for 2013.

As you can probably surmise, someone very close to me is going over the limit for the first time in 2013. Is there some definitive reference that says that that person would or would not be HCE for tax year 2013?

Also is HCE really a step function: A $1 raise, from $114,999 to $115,000 results in, effectively, loss of a $23,500 (minus 2% over the non-HCE average contribution percentage) tax shelter? Or is there some relationship between how far over the limit you are and how much of the tax shelter you lose? (I see no indication of the latter.

Finally, given that HCEs by their very nature cannot contribute to IRAs since they are "eligible" for 401ks and make "too much", are there no comparable tax shelters for wage income available? (I don't see any, myself.)
Last edited by bUU on Wed Nov 13, 2013 6:09 pm, edited 1 time in total.
livesoft
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Re: HCE Options

Post by livesoft »

The audit of the 401(k) plan (completed in March 2014?) will determine how much an HCE is able to contribute for 2013. It could be $22,141 so if more was contributed it is relatively trivial nowadays to deal with that.

And if enough of the non-HCE contribute enough, then the HCEs can contribute the max anyways.

Other tax shelters: Deferred compensation plans. I-bonds. Tax-efficient investing in taxable accounts. Muni bonds. Etc.
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Re: HCE Options [Highly Compensated Employee]

Post by LadyGeek »

This thread is now in the Personal Finance (Not Investing) forum (tax question). I also retitled the thread.
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bUU
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Re: HCE Options

Post by bUU »

livesoft wrote:The audit of the 401(k) plan (completed in March 2014?) will determine how much an HCE is able to contribute for 2013. It could be $22,141 so if more was contributed it is relatively trivial nowadays to deal with that.
The expectation is that the average non-HCE contribution is roughly 4.5%, so that would limit a marginal HCE to about $7500.
livesoft wrote:Other tax shelters: Deferred compensation plans.
Is this something that someone can do themselves (because the company won't do anything to address this situation).
livesoft wrote:I-bonds.
I have looked into I-bonds before and found them lacking overall. I guess I'll look deeper now, but regardless, I'm pretty sure they're not a tax shelter for wage income.
livesoft wrote:Tax-efficient investing in taxable accounts. Muni bonds. Etc.
Already done, but those aren't really tax shelters for wage income either.

Thanks for the input!

Does anyone have any insight into the "preceding year" issue?
Last edited by bUU on Wed Nov 13, 2013 6:08 pm, edited 2 times in total.
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Re: HCE Options [Highly Compensated Employee]

Post by dickenjb »

bUU wrote: Finally, given that HCEs by their very nature cannot contribute to IRAs since they are "eligible" for 401ks and make "too much", are there no comparable tax shelters available? (I don't see any, myself.)
Everyone with earned income can contribute to an IRA.

Not everyone can deduct all of their contribution.
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Re: HCE Options [Highly Compensated Employee]

Post by bUU »

dickenjb wrote:Not everyone can deduct all of their contribution.
Practically no HCEs with a working spouse can deduct any of their contributions to IRAs, so effectively isn't not a means of sheltering wage income. Thanks though.
killjoy2012
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Re: HCE Options [Highly Compensated Employee]

Post by killjoy2012 »

I'm a HCE at a Fortune 10 company. While our HR/payroll department handles all of the complexities of this situation, my personal experience is exactly what your reference describes. I was hired in 5 years ago, and I was not an HCE for the first 2. In November of my second year, I received a notice from HR/payroll that based on my forecasted year end earnings for that current year, that I would be classified as an HCE starting Jan of the following year, and that that classification meant I was restricted to X% pre-tax and Y% post-tax contributions to my 401k. In that January, I received formal confirmation of the HCE and our 401k administrator enforces that max contribution amount.

Does that clear things up?

The funny/sad/BS part is that while I'm just barely over the HCE threshold, and therefore cannot contribute up to the IRS maximum per year... People at my company who make another ~40k more than I do can still hit the IRS maximum, since our restricted HCE % * their salary still hits the IRS annual maximum. So, the only people being punished are the ones at the poorer end of the HCE scale.
furwut
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Re: HCE Options

Post by furwut »

bUU wrote:
Does anyone have any insight into the "preceding year" issue?
My understanding is that it means exactly what it says. It is a look back at your income in the previous year. So for 2014 HCE determination they look at income you received in the preceding year 2013 not the income you are anticipating making in 2014.

In 2012 I was HCE due to the income I made in 2011.
For 2013 I wasn't HCE because the threshold was raised and my 2012 came in just under.
I planned to switch to part-time status sometime in 2014 while continuing to contribute the max to our 401k plan. But if I finished 2013 as full time I'd break the threshold and would end up back in HCE penalty camp for 2014. So I advanced my plans and switched to part-time this fall to ensure my 2013 income fell under the threshold.

If I had remained working full time I was considering asking for a pay decrease or LWOP. It sucks to make just a few dollars over and loose the opportunity to shelter thousands.
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Re: HCE Options [Highly Compensated Employee]

Post by bUU »

Thanks for that input. It's a relief that you aren't considered HCE the first tax year you are over the limit. I am lucky enough that I was disappointed with the pay increase that put me just over the limit (which I wasn't aware of at the time I received the raise) and insisted on and secured another raise at that time, because the second raise was enough to cover the additional tax associated with losing the wage income tax shelter of the 401k once I have a full year over the HCE limit. I'm still in a take-home pay situation no better than where I was with the first raise, but I cannot complain.
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Re: HCE Options [Highly Compensated Employee]

Post by dimeat »

Are the HCE limits based on gross income or something like AGI/MAGI? I couldn't find anything so I figure it is gross income?
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Re: HCE Options [Highly Compensated Employee]

Post by bUU »

It is based strictly on gross compensation, and from that one employer. It's not based on employee income. The rule is imposed from the employer side, not the employee side, and the employer has no means, nor should have any means, to know an employee's income, adjusted or otherwise, beyond the compensation that employer pays to that employee.
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bUU
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Re: HCE Options [Highly Compensated Employee]

Post by bUU »

An update...

I found IRS Notice 97–45 which outlines somewhat clearly the whole "preceding year" thing. I also found a call for comments on the Notice from December 2012 indicating it was in force at least that recently. I provided copies of the Notice to the new plan sponsor (someone who is as motivated to address this issue as I am, finally).

The ADP testing for 2012 was done last week, and we failed. The NHCE percentage was 7.62%. There are 39 employees right now, and I think that's the same count as at the end of 2012. Within that group I think three people were HCEs. One is gone and I'm probably the only new HCE. So I'm figuring that that means that a good guess for what the NHCE percentage might be this year is this: +(7.62*(39-3)-16.04)/(39-3-1) = 7.38%. Translating: I took the average NHCE percentage 7.62 multiplied by my guess for the number of NHCEs (39-3) and subtracted my percentage 16.04 and then divided by the number of NHCEs without me (39-3-1) to get the average NHCE percentage without me. Did I miss something there? If not, then that means I should be able to contribute 7.38%+2%+$5,500 (catch-up) in 2014, since I will be over the HCE limit in 2013.

So the only question I have left is whether the fact that I'm not treated as HCE in 2013, even though I'm over the limit, means that my contribution in 2013 counts as NHCE or HCE for 2013. It wouldn't affect, but would affect the other two HCEs (albeit by only 0.24%).
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Re: HCE Options [Highly Compensated Employee]

Post by lostinjersey »

The definition of HCE pay is plan-specific. You need to check with HR or your plan administer to determine how your plan calculates HCE pay.

Assuming no big changes in the NHCE deferral rates, your estimate seems reasonable.
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Re: HCE Options [Highly Compensated Employee]

Post by downshiftme »

Or you can lobby hard for your company plan to adopt the Safe Harbor provisions, which will allow HCE to make contributions up to the legal limits and not be restricted by the percentages contributed by non-HCE.
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Re: HCE Options [Highly Compensated Employee]

Post by bUU »

My understanding is that HR has no idea and the plan administrator at Merrill Lynch has no comment.

In all my reading, the only choice I see the plan being able to make involves the definition of the look-back year, and the matter of the 20% top compensated. I don't believe I see anything that says that the plan determines how to calculate what HCEs can contribute - quite the contrary - the regulations seem to indicate that that is dictated by the regulations.

We lobbied hard (very hard) for Safe Harbor and it was denied.
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