• Client Portal
|
  • Subscribe to Newsletter
  • Request for Proposal
Legacy Retirement Solutions - Third Party Retirement Plan Administration
  • Home
  • About Us
  • Services
  • Articles
  • Resources
  • Contact Us
  • Careers
Legacy Retirement Solutions - Third Party Retirement Plan Administration
  • Home
  • About Us
  • Services
  • Articles
  • Resources
  • Contact Us
  • Careers
  • Home
  • Administration
  • Employing the Proper Definition of Compensation

Categories

  • Administration
  • Plan Design
  • Statutory / Regulatory

  • Administration

Employing the Proper Definition of Compensation

  • Posted on September 8, 2020 by Legacy Retirement Solutions

The U.S. Department of Labor (“DOL”) and the Internal Revenue Service (“IRS”) routinely report common operational failures that such agencies detect in the context of retirement plan audits and investigations.  One of the operational failures that is always at or near the top of that list concerns plan sponsors failing to employ the correct definition of compensation for purposes of performing necessary compliance testing and/or determining benefit allocations.  The following article is intended to briefly highlight some of the issues that can occur when the incorrect definition of compensation is employed as well as to provide an explanation of some of the differences between the most commonly employed definitions of compensation.

Impact of Employing the Incorrect Definition of Compensation

As suggested above, utilizing the correct compensation for each retirement plan participant is very important.  This is because compensation is a critical data point which is necessary in order to accurately calculate many different plan limits and make proper benefit calculations.  Sometimes problems occur if a plan sponsor fails to limit compensation to the maximum amount which may be considered for tax-qualified retirement plan purposes under the Internal Revenue Code.  In other situations, a plan sponsor may not understand what types of income are included within the definition of compensation.  In still other circumstances, a plan sponsor may not realize that different definitions of compensation are employed for different plan purposes.  When mistakes such as these occur, tax-qualification defects often result.

As a more specific example, compensation is employed to calculate the Average Deferral Percentage (“ADP”) and Actual Contribution Percentage (“ACP”) tests (the tests that limit the amount of “elective deferrals” and “employer matching” contribution that can be received by plan participants during a plan year).  If such tests are not performed accurately, a failing test may appear to be passing or an incorrect distributable amount may be calculated to “correct” a failing test.  Inaccurate compensation data would also result in the inaccurate calculation of salary deferral, employer matching and employer profit sharing contribution amounts.

As a result of these concerns, plan sponsors should be familiar with the terms of the plan document to ensure that they use the proper definition of compensation for nondiscrimination testing, deferral and contribution calculations and limitation purposes. It is important to recognize whether: 1) certain types of compensation are excluded for specific plan purposes; 2) compensation is limited for specific plan purposes; and/or 3) compensation is determined using different computation periods (i.e., plan year vs. calendar year).

Failure to follow the terms of the plan document, properly limit the maximum considerable compensation under the Code or satisfy the ADP and/or ACP tests are problematic and, if possible, should be corrected as soon as possible under the “Employee Plans Compliance Resolution System” (“EPCRS”) as sponsored by the IRS.  Failure to do so can result in severe consequences which, in extreme circumstances, can lead to significant penalties up to and including plan “disqualification” (the immediate taxation of the trust of the plan at issue, the immediate taxation of the participants on their assets held by such plan and the loss of the employer’s tax deduction on contributions to such plan for all “open” plan years).

Differences Between Commonly Employed Definitions of Compensation

In order to assist in illustrating some of the differences between commonly employed definitions of compensation, we have created the following chart.  However, please be aware that this chart is only a brief summary of some of the differences between the most commonly employed definitions of compensation and is by no means complete.

Item of compensation 415 Simplified Comp W-2 comp

 

Section 3401(a)

Wages

 

Salary Included Included Included
Overtime Included Included Included
Bonuses Included Included Included
Commissions Included Included Included
Tips  

Included but allocated tips are excepted

Exclude

allocated tips, noncash tips, tips under $20 per month

Same as W-2
Elective deferrals Included Included Included
Differential wage

payments to individuals in the military

Included Included Included
“Nonqualified”

moving expense reimbursements

Excluded Included Included
Nontaxable

fringe benefits

Excluded Excluded Excluded
Taxable fringe

benefits

Included Included Included
“Excess” group

term life insurance

Included Included Excluded
Taxable medical

or disability benefits

Excluded Included Included
Nonqualified

plan distributions

Excluded unless

plan provides

otherwise

Included Included

 

As much as we hope this article helped you to better understand this topic, it is not to be construed as financial, tax or legal advice.  Therefore, if you believe that the issues discussed herein may apply to your (or your client’s) company, be sure to further discuss it with a qualified retirement plan professional; more specifically, your tax and/or accounting professional.  For more information about this topic, please contact our marketing department at 484-483-1044 or your administrator at Legacy.

Prev
Important CARES Act 2020 RMD Rollover Deadline Fast Approaching
Required Minimum Distributions
Next

Recent Administrative Posts

  • ADP Test Basics Corrections
  • ADP Test Basics
  • Form 5500

Recent Plan Design Posts

  • Safe Harbor 401(k) Establishment Deadline
  • Safe Harbor 401(k) Establishment Deadlines
  • The Power of Combining Plans

Recent Statutory / Regulatory Posts

  • Tax Credit For Small Employer Start-Up Plans
  • ADP Test Basics Corrections
  • ADP Test Basics

Archived Articles A-Z

  • A-E
  • F-J
  • K-O
  • P-T
  • U-Y
  • Z-Z

A-E

  • Defined Benefit Plan Year Compliance Package
  • Delay to Deadline for Plan Sponsors to Make Retirement Plan Contributions
  • Department of Labor Releases New Guidance on Missing Participants
  • CARES Act – Retirement Plan Impact
  • Cashing-Out Terminated Employees From Your Company’s Retirement Plan
  • ADP Test Basics
  • ADP Test Basics
  • ADP Test Basics
  • ADP Test Basics
  • ADP Test Basics Corrections
  • ADP Test Corrections
  • Changes to DOL Late Deferral Remittance Enforcement Procedure
  • Changes to 404a-5 Participan Fee Disclosure Requires Additional Notifications
  • Congress Enacts Changes to Hardship Withdrawal Rules
  • Consequences of Failing to Timely Adopt a PPA Restatement
  • Employing the Proper Definition of Compensation
  • Correcting Average Deferral Percentage Test Failures
  • Correcting Average Deferral Percentage Test Failures
  • Are Your SEP Plans Safe From Other Financial Advisors?
  • Are You Ready For Your Next Plan year end?
  • ERISA Bond: What Is It and Do I Need ONe?
  • ERISA Bond: What Is It and Do I Need One?
  • A Plan Administrator’s “Due Diligence” Obligations
  • A Plan for Retirement Plan Compliance 2014
Back to top

F-J

  • Important CARES Act 2020 RMD Rollover Deadline Fast Approaching
  • Form 5500
  • Form 5500 Update
  • Form 5500 Update
  • IRS Creates Permanent Form 5500 Penalty Relief Program for Non-ERISA Plans
  • IRS Expands Retirement Plan Sponsors’ Self-Correction Options
  • IRS Expands Use of Pre-Approved Plan Documents To Cash Balance Plans
  • IRS Grants Form 5500 Penalty Relief for Non-ERISA Plans
  • IRS Grants 401(k) Safe Harbor Suspension Relief
  • IRS Issues Final Regulations on Mid-Year Reduction or Suspension of Safe Harbor Contributions
  • IRS Issues Guidance on Same Sex Marriage
  • IRS Issues Guidance Regarding Uncashed Check
  • IRS Revisits Mid-Plan Year Changes to Safe Harbor 401(k) Plans
  • IRS Provides Guidance on Expansion of In-Plan Roth Rollovers
Back to top

K-O

  • Legacy Solo(k) Plans 2016
  • NAPA Conference
  • New Opportunity In-Plan Roth Conversions
  • Limitations On Mid-Plan Year Amendments To Safe Harbor 401(k) Plans
Back to top

P-T

  • Safe Harbor 401(k) Establishment Deadline
  • Safe Harbor 401(k) Establishment Deadlines
  • Required Minimum Distributions
  • Required Minimum Distributions
  • Required Minimum Distributions
  • Tax Credit for Small Employer Start-Up Plans
  • Tax Credit For Small Employer Start-Up Plans
  • Tax Credit for Small Employer Start-Up Plans
  • Tax Credit For Small Employer Start-Up Plans
  • The SECURE Act – Plan Sponsor Impact – Part 1
  • The SECURE Act – Plan Sponsor Impact – Part 2
  • The SECURE Act – Plan Sponsor Impact – Part 3
  • The Power of Combining Plans
  • The Problem with Using Forfeitures to Satisfy Employer Contributions
  • Plan Sponsors Must Retain Hardship and Loan Documentation
  • Plan Year Compliance Package
  • Plan Year Compliance Packages
  • Solo 401(k) Brochure
  • Treasury Issues Proposed Hardship Withdrawal Regulations
Back to top

U-Y

  • What are “Cash Balance Plans”?
  • What is “New Comparability”?
Back to top

 

 

 

 

Phone: 484-483-1044     E-mail: marketing@legacyrsllc.com     Address: 700 Turner Industrial Way, Suite 110, Aston, PA 19014     Follow Us: LinkedIn

© Copyright 2019 Legacy Retirement Solutions - All Rights Reserved - Design by CrafTech Computer Solutions

 

Links

  • Overview
  • Principals
  • Staff