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Cafeteria Plan "Key" employee definition

Here is our stab at general guidelines for the current definitions for "Key", "Highly-Compensated", and "5% Owner" employees. We strongly suggest that you review the appropriate IRS code sections (105, 125, 129, 415, and 416) for the important details at:

Sec. 125

A Plan should not favor any Highly-compensated employees (HCE).  A highly compensated employee, for this purpose, is any of the following employees.

  1. An officer.

  2. A shareholder who owns more than 5% of the voting power or value of all classes of the employer's stock.

  3. An employee who is highly compensated based on the facts and circumstances.

  4. A spouse or dependent of a person described in (1), (2), or (3).


A Section 125 “Key” employee is quite analogous to Company officer. To determine if the Section 125 cafeteria plan meets the 25 percent concentration test, the PARTICIPATING employee should be marked as “Key” in the employee record if:

1) He is an officer that makes more than $170,000 per year or,

2) He is more than a 5% owner or,

3) He makes more than $150,000 per year and is more than a 1% owner

Note that several “limits” on the number of “key” employees in any company apply, and an employee may be considered “Key” if he is simply related to an owner, even if he/she does not personally meet the ownership criteria. (Fun stuff, huh?)

The Sec. 125 plan is in compliance if the total contributions (paycheck withholdings) of the “Key” employees is not more than 25 percent of the total contributions of ALL Sec. 125 participants!

Sec. 129

A similar 25 percent concentration test applies separately to Sec. 129 Dependent Care programs. The IRS code states that no more than 25 percent of benefits (contributions) in the Dependent Care program may be attributable to the group of employees (or their spouses/dependents) who own more than 5 percent of the company’s stock or profits.

An additional 55 percent discrimination test applies to Sec. 129 Dependent Care programs. Note that the Sec. 129 fifty-five percent test applies to all ELIGIBLE employees, not just Dependent Care or cafeteria plan participants. First, from the population of ALL employees, mark as “Excluded” individual employees if:

1) They are under 21 years of age

2) They have less than one year of service

3) They are covered under a collective bargaining agreement

Fast-Flex Plus will automatically make another pass and also eliminate any employee making less than $25,000 annually. (It might help you comply with the 55% test – you only need to pass one of the two!)

You will also need to mark Highly-Compensated employees. In general, an employee is considered as highly compensated (HCE) for Dependent Care benefits if:

1) He makes more than $120,000 per year or,

2) He is in the top 20 percent of the company’s ranked annual compensation

3) He owns more than 5% of the Company’s stock or profits

If the average dependent care deferral of the non-highly compensated group is at least 55 percent of the Highly Compensated Group, the Dependent Care Plan meets the Sec. 129 requirements!

Sec. 401(k)

Discrimination testing in a 401(k) plan involves comparing the ratio of 401(k) contributions divided by "eligible" wages for both the key and non-key employees. A ratio is computed separately for each participant, and then averaged for both groups. The point of discrimination testing is that highly-compensated (key) employees cannot contribute a much higher portion of their wages than do the other employees.

I. Be certain that all eligible employees are in the database. You may need to add employees who became eligible to participate mid-year, but have chosen not to contribute funds to the 401(k) plan. Note that the Company's Personnel Department should provide you with the list of eligible employees. These employees must meet three (3) criteria:

1. Their hire date must precede the enrollment date by at least 1 year.

2. They must have worked at least 1000 hours during the year prior to their enrollment.

3. They must be at least 21 years old on their enrollment date.

II. Designate highly compensated employees in the employee's record if they make more than $80,000 per year. (There may be some other criteria pertaining to stock ownership, etc.) Note also that the wage amount varies from year to year according to inflation. Check IRC Sec. 401 to get the current key employee wage amount and other criteria, then work with the employee file to designate "Highly-Compensated" and "Key" employees.