If a company's first year is the same as the plan's first year, what applies for HCE determination?

When determining Highly Compensated Employees (HCEs) for a retirement plan, it is essential to consider the factors that define who qualifies as an HCE in the context of the plan's first year.

In the scenario where a company's first year aligns with the plan’s first year, the focus for HCE determination is primarily on the 5% owner test. This test identifies individuals who own more than 5% of the company, as they are automatically classified as HCEs, irrespective of their compensation level. This is particularly important in the first year because all employees' data is limited, and there might not be enough historical compensation data to reasonably apply the compensation test effectively.

The compensation test, which evaluates employees based on their annual compensation, typically requires a complete year of payroll data to implement accurately. Hence, this test often cannot be applied reliably in the plan's initial year, where the data may be incomplete or insufficient to make definitive classifications.

Thus, for the first year of a plan, only the 5% owner test applies for determining HCEs since it is based on ownership rather than compensation, which is more challenging to assess without a full year’s worth of reliable data.