What is a Highly Compensated Employee?

Phil Hodgen

Attorney, Principal

11.1 Introduction

The U.S. tax treatment of employer contributions to and distributions from a SIPP will depend on whether the SIPP participant is a highly compensated employee and whether the SIPP is discriminatory. Both terms are defined in the Internal Revenue Code.

In this chapter, I help you make the decision of whether the SIPP participant is a “highly compensated employee”. The answer will almost always be “yes.”

The next chapter will help you decide whether the SIPP itself is a “discriminatory” plan. Again, the answer will almost always be “yes.”

11.1.1 Why “highly compensated employee” matters

Highly compensated employees who are participants in nonexempt employees’ benefits trusts (like SIPPs) do not determine their U.S. income tax liability using the default rules for contributions to and distributions. These rules are found at IRC 402(b)(1) and (2), respectively. Instead, highly compensated employees calculate their U.S. income tax liability using exceptions to the default rules, found at IRC 402(b)(4).

You can only know which rule to apply–default rule or exception–after you know whether the plan participant is (or is not) a highly compensated employee. We will look at the U.S. income taxation of contributions and distributions to a SIPP in future chapters. For now, let’s classify the participant.

11.1.2 Two ways to be a highly compensated employee

IRC 402(b)(4)(C) tells us where to find the definition of highly compensated employee, by cross-reference to IRC 414(q).

There are three ways for a SIPP participant to be a “highly compensated employee.”

One way is to be “highly compensated” in one of two ways. IRC 414(q)(1)(B).
The third way is to be an owner of the employer. IRC 414(q)(1)(A).

11.1.3 The Code: “highly compensated employee” IRC 414(q)(1) states the rule:

11.1.4 Notices

The IRS publishes a notice every year with the indexed values for the upcoming tax year. Here are the values for 2025 and 2026:

2025: $160,000 (Notice 2024-80)
2026: $160,000 (Notice 2025-67)

11.2 The highly-compensated path to highly compensated employee classification

11.2.1 $160,000 for 2025 and 2026

An employee who received compensation above an indexed threshold value might be a highly compensated employee. IRC 414(q)(1)(B)(i). Currently the threshold is $160,000 for 2026 and 2026.

“Might be” a highly compensated employee is the technically correct way to look at it. Merely earning more than the threshold is enough under one method. But the other method also requires the employee to be in the top 20% of all employees (ranked by compensation).

No employer election. Is the participant’s compensation above $160,000? IRC 414(q)(1)(B)(i).
With an employer election. Is the participant’s compensation above $160,000 AND the participant is in the top 20% of employees, ranked by compensation? IRC 414(q)(1)(B)(ii).

11.2.2 The only thing that matters is total compensation

Thus, if an employer makes the specified election, someone whose compensation far exceeds $160,000 (for 2025 and 2026) will not be a highly compensated employee if there are enough other employees who earn more.

In reality, the second method will never be used for a SIPP. The way you calculate the “top 20%” guarantees that a U.S. participant in a SIPP will always be in the top 20%, even if everyone in the company earns more than him. The technical explanation will follow below.

This means that highly compensated employee status for a U.S. participant in a SIPP will always and only depend on “compensation” amount.

11.2.3 Use the preceding year’s compensation

Determine whether you are a highly compensated employee based on compensation received for the preceding year–not the current tax year. IRC 414(q)(1)(B)(i) says (emphasis added):

If you are deciding whether a SIPP participant is a highly compensated employee for the 2025 income tax year, you will be looking at 2024 compensation.

11.2.4 Compensation includes the employer’s SIPP contribution

“Compensation” is defined in IRC 414(q)(4) by cross-reference to IRC 415(c)(3):

And IRC 415(c)(3) is not particularly helpful. The relevant portion is IRC 415(c)(3)(A):

The useful definitions are in the Regulations. “Compensation” means, when you boil it down, (1) something that came from the employer, and (2) was included in gross income of the employee. Reg. §1.415(c)-2(a).

Salary is obviously included in compensation. For our purposes, the employer’s SIPP contribution is included in gross income, too. IRC 402(b)(1) says (emphasis added):

11.2.5 Examples

Here are two examples that show how inclusion of the employer’s SIPP contribution will push the U.S. employee’s status to “highly compensated employee.” Assume in both cases that the only two items of compensation are salary and the SIPP contribution.

Example 1.
An employee receives salary in GBP equivalent to $140,000 in 2025. No other fringe benefits or oddities are provided by the employer. In determining the employee’s status as a highly compensated employee for 2026, the employee’s total compensation is $140,000 (salary only), below the threshold for 2026 of $160,000. Therefore, the employee will not be a highly compensated employee in 2026.

Example 2.
An employee receives salary in GBP equivalent to $140,000 in 2025. The employer also makes a SIPP contribution in the GBP equivalent amount of $25,000. The SIPP contribution is included in the employee’s gross income by IRC 402(b)(1). No other fringe benefits or oddities are provided by the employer. In determining the employee’s status as a highly compensated employee for 2026, the employee’s total compensation is $140,000 (salary) plus $25,000 (SIPP contribution) for a total of $165,000, above the threshold for 2026 of $160,000. Therefore, the employee will be a highly compensated employee in 2026.

11.2.6 Conclusion

A U.S. person who is an employee will be a highly compensated employee for the current tax year if total compensation in the previous year exceeds an inflation-adjusted threshold. For determining highly compensated employee status for tax years 2025 and 2026 the threshold is $160,000. This includes all compensation items, and specifically includes the employer's SIPP contribution made on behalf of the employee.