An employee is considered to be a highly compensated employee by the IRA if they fulfill any of these two requirements:
- Has at least five percent of the business's shares, regardless of whether the company is public or private.
- Have earned more than $135,000 in 2022 or $130,000 in either 2021 or 2020, respectively. And if the employer so chooses, was among the top twenty percent of earnings at the firm.
For instance, an employee whose yearly remuneration consists of a base salary of $120,000 and a bonus of $20,000 would have a total annual compensation of $140,000 if these two components were combined. As a result, we would refer to them as highly compensated employees. In addition, a person who owns 7% of the firm would also be designated an HCE, even if their annual pay was just $30,000. This is because HCEs are required to have a certain level of control over the company.
What is the Typical Workload of a Highly Paid Employee?
IRS uses a tax category known as "highly compensated employee" to categorize some individuals for tax purposes (IRS). It is unrelated to a person's level of financial security or how satisfied they are with their compensation. Ownership and compensation tests are the two methods by which the IRS will assess whether or not you have an HCE.
If you or a member of your immediate family owns at least five percent of the business, you are considered a highly compensated employee. According to the Internal Revenue Service (IRS) family attribution regulations, if your spouse, child, grandparent, or parent owns at least 5% of that firm, you are automatically designated an HCE. It does not matter how much money you earn — whether it is $20,000 or $2,000,000 — to be labeled an HCE, you or a member of your family must hold at least 5% of the company.
Compensation Test
Because of the amount of money you make, you can also be considered a highly compensated employee. If you own less than 5% of the firm, the only way you may be designated an HCE is if you earned at least $135,000 in total pay in 2022, or if it's for 2021 or 2020, then it's $130,000. The HCE limitations are subject to annual adjustments by the IRS to account for inflation.
A salary of 135 000 dollars is regarded as a high pay in many regions. However, if you reside in a large city such as New York or San Francisco, you may still feel that you are living paycheck to paycheck, even though your income is sufficient to classify you as an HCE.
Exactly What This Implies for Private Investors
The Internal Revenue Service has a very good reason for defining a highly compensated employee in a certain way. The tax benefits may be better determined with this categorization. The IRS divides workers into two categories: HCEs and NHCEs. After that, it conducts checks on company's benefits, to ensure that the HCE contribution does not exceed the NHCE contributions by a margin of more than 2%.
If an employer is found to violate the regulations, the benefits offered by the firm might lose their tax-exempt status, which would put the employee contributions at risk. Therefore, it is in a corporation's best interest to maintain compliance with applicable laws and refrain from engaging in discriminatory practices.
Drawbacks
Being a highly compensated employee comes with a few negatives, even though highly compensated people may enjoy greater salaries or ownership in the firm. To begin, HCEs could be subject to more stringent restrictions on the maximum proportion of their wage that they are allowed to contribute.
The Internal Revenue Service administers two types of nondiscrimination testing for corporations' 401(k) plans: the ADP test and the ACP. In essence, it seeks to guarantee that the 401(k) contributions made by typical workers and highly compensated employees would be proportionate to one another. A significant part of the purpose of these examinations is to differentiate between the workers who are HCEs and those who are NHEs.
Retirement Savings Options
IRAs
To a typical Individual Retirement Account (IRA), one must have earned income to make contributions. The maximum contribution to a regular or Roth IRA in 2022 is $6,000. If you are at least 50 years old, you are eligible to donate $7,000.
