What Is the Definition of a Highly Compensated Employee?


Quick Answer

A highly compensated employee (HCE) is an individual who owns at least 5 percent of a company or earned more than $115,000 from the company in the preceding year, as of 2014. An employer can choose an HCE if the individual's income ranks among the 20 percent highest-paid employees.

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The Internal Revenue Service (IRS) adjusts the qualifying annual income for a highly compensated employee each year. The IRS conducts non-discrimination tests to determine whether the 401k contributions of HCEs are extremely higher than the contributions of regular employees. A company that fails the non-discrimination test must refund some of the contributions to HCEs; such refunds are taxed. In some cases, a company can distribute a non-elective contribution to the non-HCEs instead of refunding such contributions to HCEs.

The human resources department can design the company's 401k plan as a safe harbor plan so that it is not liable for a discrimination test by the IRS. The human resources department can also convince more employees to start contributing or to increase their 401k contributions in order for a company to pass the non-discrimination test.

An HCE can use a non-qualified contribution plan with a shorter time frame in order to save more than the standard limit of $17,500. This is applicable for HCEs whose 401k contributions are limited by the IRS discrimination tests.

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