Compensation for retirement plan purposes is defined within the governing Plan Documents. The compensation that your plan considers will determine what pay is used for plan purposes - such as non-discrimination testing, pre-tax salary deferrals (including Roth deferrals), and employer contributions, to name a few.
Factors contributing to you decision as to which type of compensation your plan will use are numerous. You might have a calendar year plan (plan year ending 12/31) in which case you may consider W-2 compensation for your plan. However, if your fiscal year and plan year are off-calendar, 9/30 for example, you might want to consider Withholding, also known as Section 3401(a) wages.
Other factors to consider:
These are only a few factors to consider. Your design consultation will cover plan compensation in more detail.
There are four main types of plan compensation:
Thanks to our friends at the IRS, we're able to provide you the below chart. This chart outlines compensation types and items that are included and excluded by default. Further exclusions can be defined in your plan beyond those listed below for each compensation type.
| Compensation Item | Statutory Definition (1.415(c)-2(a)--2(c)) | Simplified Comp. (1.415(c)-2(d)(2)) | W-2 Comp (1.415(c)-2(d)(4)) | Section 3401(a) wages (1.415(c)-2(d)(3)) |
| Salary | Included | Included | Included | Included |
| Overtime | Included | Included | Included | Included |
| Bonuses | Included | Included | Included | Included |
| Commissions | Included | Included | Included | Included |
| Tips | Included, but allocated tips are arguably excepted | Same as current includible compensation | Exclude allocated tips, noncash tips, tips under $20 per month | Same as W-2 |
| Elective deferrals | Included | Included | Included | Included |
| Differential wage payments to individuals in the military |
Included | Included | Included | Included |
| Regular compensation paid after severance from service |
Included | Included | Included | Included |
| Severance pay | Excluded | Excluded | Excluded | Excluded |
| Expense reimbursements - accountable plan |
Excluded | Excluded | Excluded | Excluded |
| Expense reimbursements – non-accountable plan |
Included | Included | Included | Included |
| "Qualified" moving expense reimbursements | Excluded | Excluded | Excluded | Excluded |
| "Nonqualified" moving expense reimbursements | Included | Excluded | Included | Included |
| Nontaxable fringe benefits | Excluded | Excluded | Excluded | Excluded |
| Taxable fringe benefits | Included | Included | Included | Included |
| "Excess" group term life insurance | Included | Included | Included | Excluded |
| Taxable medical or disability benefits |
Included | Excluded | Included | Included |
| Worker’s compensation | Excluded | Excluded | Excluded | Excluded |
| Section 83 property that become freely transferable or no longer subject to substantial risk of forfeiture | Excluded | Excluded | Included | Included |
| Income attributable to Section 83(b) election |
Included | Excluded | Included | Included |
| Nonqualified plan contributions excludable in year of contribution | Excluded | Excluded | Excluded | Excluded |
| Nonqualified plan distributions | Excluded unless plan provides otherwise |
Excluded unless plan provides otherwise | Included | Included |
| Statutory stock options - grant or exercise |
Excluded | Excluded | Excluded | Excluded |
| Non-statutory stock option includible in income in year granted |
Included | Excluded | Included | Included |
| Non-statutory stock option - income includible in year of exercise |
Excluded | Excluded | Included | Included |
Source: IRS Compensation Chart (https://www.irs.gov/pub/irs-tege/epchd304.pdf)
In order for a qualified plan to demonstrate non-discrimination, provide for employee elective deferrals, and offer employer contributions, among other benefits, the retirement plan must define “compensation.” The definition of compensation is a critical component to the plan structure, design, operations, and compliance. Not only must the plan’s definition of compensation past muster, it must also be adhered to for operational compliance.
Operational Compliance (OC) is a term we use to identify whether or not you are operating the plan in accordance with its terms. For instance, your plan’s definition of compensation may exclude bonus pay for HCEs and NHCEs for all plan purposes. In this instance, you would not apply participant elections on bonus pay.
Example: Mary, a highly compensated employee (HCE) by way of stock attribution from her mother's 100% ownership in Company A, elects to have 5% withheld pre-tax for the plan year. Mary receives a bonus of $1,000 which payroll has included with her regular pay. Payroll should only apply the 5% election to compensation that is considered by the plan. The $50 that would otherwise have been withheld from her $1,000 bonus is not considered for plan purposes in this example and if contributed would be an ineligible contribution which would require corrective measures be taken for proper removal and/or segregation.
Note that in our example the bonus pay is commingled with regular pay; this could potentially lead to a failure in operational compliance if payroll erroneously applied Mary's 5% election to the entire gross pre-tax pay for that check. Should this happen there are corrections that would need to be performed - that's where we here at Uniglobal come in to assist you with not only identifying these compliance issues but aiding in the correction.
If you have questions about Operational Compliance and would like a review contact us!