Key Employee

A key employee is an employee who, at any time during the plan year, falls into one of the three categories in Internal Revenue Code section 416(i)(1)(A): an officer of the employer whose annual compensation is greater than a figure the statute indexes each year, a 5-percent owner of the employer, or a 1-percent owner whose annual compensation from the employer is more than $150,000. Ownership is measured with the constructive-ownership rules of section 318, so family holdings can be attributed to someone who owns nothing in their own name. Anyone who is not a key employee is, in the statute's own words, a non-key employee.

The term exists to serve one test. Section 416 asks whether a retirement plan has become top-heavy, meaning that more than 60 percent of its value sits with key employees, and if it has, the employer owes a minimum contribution to everyone else. The published top-heavy plan entry covers that test and its consequence; this page covers who gets counted.

It is worth separating this from a term that sounds like it and is not. A highly compensated employee is defined by section 414(q) for nondiscrimination testing, using a different threshold and a different structure. The most consequential difference is that section 414(q) has no officer prong whatsoever, while section 416(i) leads with one. A person can easily be one and not the other, and treating the two labels as interchangeable is the most common error in this corner of plan law.

The officer prong, and the cap that keeps it honest. The statute's first category is an officer of the employer having annual compensation greater than $130,000, and a following sentence directs that the $130,000 be adjusted at the same time and in the same manner as under section 415(d), in $5,000 increments rounded to the next lower multiple of $5,000. That is why the working figure is $235,000 for 2026 rather than the number printed in the Code. Then comes the limit: "no more than 50 employees (or, if lesser, the greater of 3 or 10 percent of the employees) shall be treated as officers." A business with 40 employees can treat at most 4 of them as officers for this purpose; a business with 12 can treat at most 3. Officer status here is a question of function and authority rather than of what a business card says, and the cap means a company cannot expand the key employee group simply by expanding the title. Which officers the cap leaves out, where a company has more than the cap allows, is answered by the regulations under section 416 rather than by the statute.

The two ownership prongs work very differently from each other. A 5-percent owner is anyone who owns more than 5 percent of the outstanding stock, or stock with more than 5 percent of the combined voting power, of a corporate employer, or more than 5 percent of the capital or profits interest where the employer is not a corporation. That prong has no compensation requirement at all: an owner earning nothing is still a key employee. A 1-percent owner is the same test with 1 percent substituted, and that prong does carry a compensation requirement of more than $150,000. The $150,000 is a fixed statutory amount. The indexing sentence in section 416(i)(1)(A) reaches only the $130,000 in the officer clause, so wage growth alone pulls steadily more small owners across the 1-percent line over time without Congress doing anything.

Ownership is not counted the way a cap table counts it. Section 318's constructive-ownership rules apply, with one modification the statute makes expressly: the 50 percent threshold in section 318(a)(2)(C) is read as 5 percent for this purpose. Stock owned by a spouse, child, grandchild or parent can be attributed to an employee who holds none personally, which is how a family business ends up with key employees who would deny being owners. In the other direction, section 416(i)(1)(C) switches off the controlled-group and affiliated-service-group aggregation rules of section 414(b), (c) and (m) for the ownership determination, so ownership is tested against the employer entity rather than across the whole related group.

Three smaller rules that change the count. Officers and employees of an entity maintaining a governmental plan under section 414(d) are excluded from key employee status outright. Employees described in section 414(q)(5), the short-service and young and part-time categories a plan may disregard, are left out when counting how many officers there are, which matters most at a business with heavy seasonal or part-time staffing. And the statute provides that "employee" and "key employee" include their beneficiaries, so a deceased participant's balance does not quietly move to the other side of the test.

What the label does not do. Key employee status caps nothing. It does not limit what the person may defer, does not reduce an employer contribution to them, and does not restrict any benefit. It determines whose account balances go in the numerator of a concentration test, and the burden of failing that test falls on the employer, in the form of a minimum contribution owed to the employees who are not key.

1. Fix the plan year. The test asks who was a key employee at any time during the plan year, so a person who held the status for one month held it for the year.

2. Identify the officers, then apply the cap. Count no more than 50, or if the workforce is smaller, the greater of 3 or 10 percent of employees, disregarding the section 414(q)(5) categories when counting.

3. Test each officer's compensation against the indexed figure, $235,000 for 2026, using compensation as section 414(q)(4) defines it.

4. Run the ownership tests, applying section 318 attribution with 5 percent substituted for 50 percent in section 318(a)(2)(C), and without the section 414(b), (c) and (m) aggregation rules. More than 5 percent is enough on its own; more than 1 percent needs compensation above $150,000.

5. Drop out the exclusions. Governmental plan officers and employees are not key employees.

6. Everyone left over is a non-key employee, and the resulting split is what the top-heavy concentration test measures.

Consider an example, with invented figures. Meridian Fabricating has 28 employees, so the officer cap is the greater of 3 or 10 percent of 28, which is 3. Rosa is president, is paid $310,000 and owns 40 percent of the company. Dev is chief financial officer and is paid $265,000 with no ownership. Ani is vice president of operations, paid $250,000, with no ownership. All three are officers paid above $235,000, and all three are key employees; Rosa would have been one on her ownership alone even if she had taken no salary.

Two other people show why the prongs matter separately. Bo runs the machine shop, is not an officer, is paid $160,000, and holds 1.5 percent of the company. He is a key employee under the 1-percent owner prong, because his pay is above $150,000. Rita is the company's best salesperson, is paid $300,000, holds no equity and is not an officer. She is not a key employee at all, because section 416(i) has no compensation-only category. She is very likely a highly compensated employee under section 414(q), which is a different test run for a different reason, and that difference is exactly the one people collapse.

What the definition gets right

• It reaches economic control rather than job titles, by pairing an officer test with two ownership tests and applying family attribution to both.
• The officer cap stops a small employer from diluting the test by handing out officer titles.
• The 5-percent owner prong has no pay requirement, so an owner who takes no salary in a lean year cannot drop out of the group.
• Anyone not captured is a non-key employee by definition, so there is no third category to argue about.

Where it causes trouble

• It is constantly confused with highly compensated employee, which is a different section, a different threshold and a different purpose, and which has no officer prong.
• The $150,000 in the 1-percent owner prong is not indexed, so the prong silently widens every year as pay rises against a fixed number.
• Attribution under section 318 makes people key employees who own nothing personally, and that is easy to miss until a plan fails a test.
• Because the status attaches if it is held at any time during the plan year, a mid-year promotion or a mid-year share purchase can change the answer retroactively for the whole year.
• Two different sets of aggregation rules apply to different parts of section 416, and the ownership determination is the part where the 414(b), (c) and (m) rules are switched off, which is counterintuitive.