The question we will answer in this issue: When do changes in the dollar threshold for determining highly compensated employees take effect?
Q: In November 2018, the IRS announced an increase in the dollar threshold for determining who is a highly compensated employee. When will that affect our 401(k) plan’s nondiscrimination testing?
A: A 401(k) plan administrator conducting nondiscrimination testing must identify highly compensated employees for the year being tested. But highly compensated employee status for a testing year is not determined by an employee’s compensation during that year. Rather, it is determined by the employee’s compensation during a 12-month period immediately preceding the testing year (often called the “look-back year”). Thus, if a calendar-year plan is being tested for nondiscrimination during its 2019 plan year, the plan administrator will look at employees’ 2018 compensation to determine whether they are highly compensated employees for 2019. The applicable dollar threshold will be the one in effect for 2018 ($120,000).
For calendar years 2015-2018, the compensation threshold used to identify highly compensated employees was $120,000. For 2019, however, the compensation threshold increased to $125,000. That amount will not be applicable to a calendar-year plan until the plan’s 2020 testing year, because highly compensated employee status in that year will depend on employees’ compensation during 2019, the first year in which the $125,000 threshold applies.
For non-calendar-year plans, the situation is a little more complicated, because those plans can determine highly compensated employee status using either the 12-month period immediately preceding the testing year (the default), or they can make a calendar-year data election and determine highly compensated employee status for a testing year based on compensation during the calendar year that begins in the look-back year. For example, if a non-calendar-year plan’s testing year begins on April 1, 2019, and ends on March 31, 2020, the look-back year is April 1, 2018, to March 31, 2019.
If the plan didn’t make a calendar-year data election, the dollar threshold for 2018 ($120,000) — the calendar year in which the look-back year began — would apply and, for the testing year ending March 31, 2020, highly compensated employees would be those earning $120,000 from April 1, 2018, through March 31, 2019. But if the plan made a calendar-year data election, it would use the dollar threshold for 2019 ($125,000) because that is the threshold for the calendar year beginning in the look-back year. In that case, for the testing year ending March 31, 2020, highly compensated employees would be those earning at least $125,000 during the 2019 calendar year. Note that the calendar-year data election must be applied consistently for all plans (both retirement and nonretirement) and must be reflected in the plan document for any plan that contains the highly compensated employee definition.
Our firm provides the information in this e-newsletter for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this e-newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.
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