Highly compensated employee (HCE)

What an HCE is

The tax code defines an HCE with two tests. An employee is an HCE for a plan year if either is true:

• Ownership: they owned more than 5% of the company at any time during the plan year or the year before. Ownership is attributed between family members, so an owner’s spouse, children, parents and grandparents who work for the company are HCEs too.

• Pay: they earned more than the indexed threshold from the employer in the prior year. Pay above $160,000 in 2025 makes someone an HCE for 2026.

A plan can elect to limit the pay test to the top 20% of employees ranked by pay. Everyone who is not an HCE is a non-highly compensated employee (NHCE).

Why it matters to employers

HCE status drives the ADP and ACP tests. If NHCEs save little, HCEs are limited in what they can defer, or get money back after year end. Knowing your HCE list early lets you warn the people affected and consider fixes such as a safe harbor design or automatic enrollment.

Example

An engineer earned $165,000 in 2025 and owns no stock. She is an HCE for the 2026 plan year, even if her 2026 pay drops. A founder’s son who earns $48,000 working at the company is an HCE because his parent owns more than 5%.

The threshold rises to $170,000 for pay earned in 2027, which sets who is an HCE for the 2028 plan year. (IRS Notice 2026-66)

Common mistakes

• Using current-year pay for the pay test. It looks back one year.

• Missing family attribution.

• Counting only base salary. The test uses total compensation, including bonuses, commissions and the employee’s own deferrals.

• Ignoring related companies. Ownership and pay are measured across a controlled group.

• Treating HCE and key employee as the same list.