The Internal Revenue Code contains a rule that basically says that if 60% or more of the money in the plan belongs to owners and highly paid officers, certain contributions must be made by the plan sponsor to all of the other eligible employees. Just to be clear, that is an incredibly brief summary of a considerable amount of regulation. Hopefully it’s enough for you to get a general idea though of the concept.
There are two types of errors here. In the first error, the test to determine if 60% or more of the money in the plan belongs to owners and highly paid officers, the “top heavy test”, is not performed. In the second error, the required contributions either aren’t made or aren’t properly made. These contributions are called “top heavy minimum contributions”. Most top heavy errors occur in small plans as larger plans tend not to be top heavy, i.e. owners and highly paid officers have less than 60% of the money in the plan.
Some plans use on-line self-service models to complete their testing. In order for these models to work, employee information about ownership and officer status and family relationships must be coded in the system. Determining who is an officer is based on job function, not job title. Ownership is as simple as direct ownership. There is also indirect ownership such as a husband is considered to own his wife’s stock and vice versa. Some systems go further and ask you to determine which employees will be considered “key employees”, a.k.a. the highly paid owners and officers for the purposes of this test. Still other service providers will ask for the information and rely on you to properly identify everyone. If the basic data is incorrect, the test will be incorrect.
In the event the top heavy test says the top heavy minimum contributions must be made, the law specifies how to calculate these contributions. Let’s say that the plan provides contributions based on gross compensation less bonuses. Well, the top heavy minimum contributions must be calculated on gross compensation. Yes, the law in this case overrides the plan provisions.
What if the plan says no one who works less than 1,000 hours in the year gets a top heavy minimum contribution? Well, the top heavy rules require contributions for all who are eligible for the plan and employed on the last day of the year. Again, the law overrides the plan provisions.
In the end, someone must perform the test correctly. And, if the test says the top heavy minimum contributions must be made, calculate those minimum contribution amounts correctly.