Key Employee: The IRS Term for Highly Compensated Employees

What is a Key Employee?

A key employee is an employee with major ownership and/or decision-making role in the business. Key employees are usually highly compensated either monetarily or with benefits, or both. Key employees may also receive special benefits as an incentive both to join the company and to stay with the company.

Understanding Key Employee

The term key employee is also used by the Internal Revenue Service. The IRS uses this term with regard to company-sponsored defined contribution retirement plans. It refers:

  • to an employee who owns more than 5 percent of the business,
  • owns more than 1% of the business,
  • and has annual compensation greater than a certain amount or is an officer with compensation greater than a certain amount.

How a Key Employee Affects a Business

From an internal perspective, apart from the IRS classification, a key employee may be considered to be an intrinsic part of a company’s operations. Such an employee could be influential in securing capital for the business, which may occur through their connections or by virtue of their work.

Key Takeaways

  • Key employees are often considered crucial to a company's operations. 
  • Key employees may enjoy monetary bonuses and other benefits. 
  • Employers may address compensation for key employees in a different manner than other staff members.

For example, the employee may hold a role tied directly to sales channels for the company, intertwining their performance and business activities with the cash flow. The employee might be the top-performing salesperson at the company, driving a significant portion of the regular revenue. The employee, for a variety of reasons, may represent a public face associated with the company’s brand and is thus seen as crucial to maintaining the investment and support of shareholders and customers.

There are other IRS and government rules that have different definitions of "key employee" for different purposes.

The company may define the work of the employee as vital to the infrastructure and operation of the business, even though that employee may not have a highly-visible role in terms of the public or outside business relations.

For instance, the chief scientist on a team developing a novel new product expected to be a mainstay behind the business’s revenue and income could be regarded as a key employee.

Special Considerations

Employers may feel the need to address compensation for key employees differently from the majority of the staff beyond providing salary. This can include offering a variety of options for them to save for retirement or presenting them work-life balance benefits to keep them engaged in the business.

Conversely, employers might adopt a different stance if a key employee makes use of the Family and Medical Leave Act to take unpaid leave from work. Such employees, who may rank among the top 10 percent of salaried workers at a company, might not be reinstated by the employer under certain circumstances.

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