Definition of Highly Compensated Employee -- Temporary Regulations Under Section 414(Q)

 [4830-01]

 ACTION: Temporary Rule.

 SUMMARY: This document contains temporary regulations relating to the scope and meaning of the term "highly compensated employee" in section 414(q) of the Internal Revenue Code of 1986. They reflect changes made by the Tax Reform Act of 1986 (TRA '86) and conform the existing regulations to section 1114(a) of the Tax Reform Act of 1986, Pub. L. No. 99-514, 100 Stat. 2085, 2448. These temporary regulations provide guidance necessary to comply with the law and will affect sponsors of, and participants in, pension, profit-sharing and stock bonus plans, and certain other employee benefit plans. The text of the temporary regulations set forth in this document also serves as the text of the proposed regulations for the notice of proposed rulemaking that appears in the Proposed Rules Section of this issue of the Federal Register. These temporary regulations are issued in conjunction with proposed regulations concerning qualified separate lines of business under section 414(r) that also appears in the Proposed Rules Section of this issue of the Federal Register.

 EFFECTIVE DATE: These temporary regulations are effective for years beginning on or after January 1, 1987.

 FOR FURTHER INFORMATION CONTACT: Thomas G. Schendt or Rhonda G. Migdail, Office of the Assistant Chief Counsel (Employee Benefits and Exempt Organizations), at 202-633-0849 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

BACKGROUND

This document amends the Income Tax Regulations (26 CFR Part 1) under section 414(q) of the Internal Revenue Code of 1986 (Code). These amendments conform the regulations to section 1114(a) of the Tax Reform Act of 1986 (TRA '86).

AMENDMENT OF PROPOSED AND TEMPORARY REGULATIONS

 Section 1.414(q)-1T, Highly Compensated Employee, was originally published, with section 1.414(s)-1T, Compensation, in the Federal Register on February 19, 1988, as temporary regulations as well as the text of proposed regulations to amend the Income Tax Regulations to conform to section 1114(a) of the Tax Reform Act of 1986 (the "prior regulations"). See 53 FR 4965, 4999. Comments were solicited and a hearing was held on December 4, 1989. The definition of highly compensated employee in section 414(q) and section 1.414(q)-1T has been partially revised in conjunction with the development of proposed regulations under section 414(r) relating to qualified separate lines of business. These revisions to section 1.414(q)-1T are now reissued as temporary regulations and the text of proposed regulations in order to clarify their use in applying the qualified separate line of business rules under section 414(r).

HIGHLY COMPENSATED EMPLOYEES

 Section 414(q) and section 1.414(q)-1T provide rules for determining which employees are "highly-compensated employees." This term is used in various Code sections relating to qualified retirement plans, qualified cash or deferred arrangements, and certain other employee benefit plans for the purpose of determining whether these plans discriminate in favor of highly compensated employees.

 One category of highly compensated employees are officers of the employer with compensation above a certain level. A second category are employees whose compensation from the employer exceeds $50,000 and who are among the top-paid group of employees (i.e., among the top 20 percent of employees when ranked by compensation from the employer).

 The determination of which employees are in the officer category and the determination of the number of employees in the top-paid group are made by excluding certain employees. These excluded employees are enumerated in section 414(q)(8) and (11). Section 1.414(q)-1T, Q&A-9, implements these statutory exclusions. In general, an employee is an excluded employee for this purpose if the employee (1) has not completed 6 months of service, (2) works less than 17-1/2 hours per week, (3) works less than 6 months during the year, (4) has not attained age 21, (5) is covered under a collective bargaining agreement, or (6) is a nonresident alien with no U.S.- source earned income from the employer.

QUALIFIED SEPARATE LINE OF BUSINESS RULES

 Section 414(r) provides rules for determining whether an employer is treated as operating qualified separate lines of business for certain purposes, including the minimum coverage and minimum participation requirements under sections 410(b) and 401(a)(26) for qualified retirement plans. Under section 414(r)(2)(A), a qualified separate line of business must have at least 50 employees on each day of the year. For this purpose, certain employees are excluded in determining whether the 50-employee requirement is satisfied.

 Although generally the same, there are some differences under the regulations between the excludable employees for purposes of the 50-employee requirement under section 414(r) and the excludable employees for purposes of determining the officer group and the top- paid group of employees under section 414(q). First, for purposes of the 50-employee requirement, the employer may not elect to apply minimum age or service requirements lower than those specified in section 414(q)(8)(A), (B), (C), and (D). Second, collectively bargained employees are not excluded for purposes of the 50-employee requirement. Finally, the applicable period for determining the exclusions for purposes the 50-employee requirement is not based on the determination year or look-back year under section 414(q), but rather on the testing year specified in the regulations under section 414(r).

EFFECTIVE DATE OF THESE TEMPORARY REGULATIONS

 These revised temporary regulations are effective for plan years beginning on or after January 1, 1987. However, for plan years beginning before January 1, 1991, compliance with either the provisions of these revised temporary regulations or the provisions of the prior regulations constitutes compliance with these revised temporary regulations.

SPECIAL ANALYSES

 It has been determined that these rules are not major rules as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis is not required. It has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. Chapter 5) and the Regulatory Flexibility Act (5 U.S.C. Chapter 6) do not apply to these temporary regulations, and therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking for the regulations is being submitted to the Chief Counsel on Advocacy of the Small Business Administration for comment on their impact on small business.

DRAFTING INFORMATION

 The principal authors of these temporary regulations are Thomas G. Schendt and Rhonda G. Migdail, Office of the Assistant Chief Counsel (Employee Benefits and Exempt Organizations), Internal Revenue Service. However, other personnel from the Service and Treasury Department participated in their development.

LIST OF SUBJECTS IN 26 CFR 1.401-0 - 1.425-1

 Employee benefit plans, Employee stock ownership plans, Income taxes, Individual retirement accounts, Pensions, Stock options.

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly 26 CFR Part 1 is amended as follows:

INCOME TAX REGULATIONS (26 CFR Part 1)

Paragraph 1. The authority citation for Part 1 is amended by adding the following citation to read as follows:

Authority: 26 U.S.C. 7805. * * * section 1.414(q)-1T is also issued under 26 U.S.C. 414(q).

Par. 2. In section 1.414(q)-1T, Q-9 is republished and A-9 is amended by revising the introductory text of paragraph (b)(1), by revising paragraph (b)(2)(iii), and by adding a new paragraph (g), to read as follows:

SECTION 1.414(g)-1T HIGHLY COMPENSATED EMPLOYEE (TEMPORARY).

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Q-9: How is the "top-paid group" determined?

A-9:

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(b) NUMBER OF EMPLOYEES IN THE TOP-PAID GROUP -- (1) EXCLUSIONS. The number of employees who are in the top-paid group for a year is equal to 20 percent of the total number of active employees of the employer for such year. However, solely for purposes of determining the total number of active employees in the top-paid group for a year, the employees described in paragraph (b)(l)(i), (ii), and (iii) of this A-9 are disregarded. Paragraph (g) of this A-9 provides rules for determining those employees who are excluded for purposes of applying section 414(r)(2)(A), relating to the 50-employee requirement applicable to a qualified separate line of business.

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(2) ALTERNATIVE EXCLUSION PROVISIONS * * *

(iii) METHOD OF ELECTION. The elections in this paragraph (b)(2) must be provided for in all plans of the employer and must be uniform and consistent with respect to all situations in which the section 414(q) definition is applicable to the employer. Thus, with respect to all plan years beginning in the same calendar year, the employer must apply the test uniformly for purposes of determining its top-paid group with respect to all its qualified plans and employee benefit plans. If either election is changed during the determination year, no recalculation of the look-back year based on the new election is required, provided the change in election does not result in discrimination in operation.

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(g) EXCLUDED EMPLOYEES UNDER SECTION 414(r)(2)(A) -- (1) IN GENERAL. This paragraph (g) provides the rules for determining which employees are excluded employees for purposes of applying section 414(r)(2)(A), relating to the 50-employee requirement applicable to a qualified separate line of business.

(2) EXCLUDED EMPLOYEES -- (i) AGE AND SERVICE EXCLUSION. All employees are excluded who are described in paragraph (b)(l)(i) of this A-9 (relating to exclusions based on age or service). For this purpose, the rules in paragraphs (e) and (f) of this A-9 (relating respectively to the 17-1/2 hour rule and the 6-month rule) apply. However, the election in paragraph (b)(2)(i) of this A-9 (permitting the employer to elect reduced minimum age or service requirements) does not apply.

(ii) NONRESIDENT ALIEN EXCLUSION. All employees are excluded who are described in paragraph (b)(l)(ii) of this A-9 (relating to the exclusion of nonresident aliens with no U.S.-source income from the employer).

(iii) INCLUSION OF EMPLOYEES COVERED UNDER A COLLECTIVE BARGAINING AGREEMENT. All employees are included who are described in paragraph (b)(l)(iii)(A) of this A-9 (relating to employees covered under a collective bargaining agreement), and who are not otherwise described in paragraph (g)(2)(i) or (ii) of this A-9. For this purpose, the exclusion in paragraph (b)(1)(iii)(B) of this A-9 and the related election in paragraph (b)(2)(ii) of this A-9 do not apply.

(3) APPLICABLE PERIOD. The determination of which employees are excluded employees is made on the basis of the testing year specified in the regulations under section 414(r) and not on the basis of the determination year or the look-back year under section 414(q).

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There is a need for immediate guidance with respect to the provisions contained in this Treasury decision. Section 414(q) is generally applicable to provisions that refer to it for years beginning on or after January 1, 1987. For this reason, it is therefore found impracticable and contrary to the public interest to issue this Treasury decision with notice and public procedure under section 553(b) of Title 5 of the United States Code or subject to the effective date limitation of section 553(d) of that title.