How to Correct Compensation Issues (Part 3 of 3)
As previous articles have detailed, qualified retirement plan compensation is not an easily defined term and there are many variables that a plan sponsor should contemplate prior to selecting the definition of compensation that best serves the plan. Regardless of the complexity of the plan’s definition of compensation, there are times when the plan sponsor does not follow the plan’s definition and correction subject to IRS guidelines must occur. Two of the more common errors and their respective corrections are below.
Excluding a type of compensation that is not excluded by the plan’s current definition
Common compensation types that plan sponsors improperly exclude are gift cards and cash service awards. Unless explicitly excluded under an IRC 414(s) exclusion in the plan’s adoption agreement, gift cards and service awards are includable in all four 415(c) definitions of compensation. Both types of compensation are taxable fringe benefits. Plan sponsors who improperly exclude these types of compensation excluded them because they are fringe benefits—which are excluded in the 415(c) definitions of compensation if they are non-taxable. That is what causes the confusion. Only non-taxable fringe benefits are excluded under IRC 415(c) definitions of compensation. Taxable fringe benefits are included in IRC 415(c) definitions. Once the error has been found and the missed compensation has been determined for each participant, the plan sponsor must correct the missed deferrals and match if applicable and recalculate any non-elective employer contributions allocated based on compensation.
The missed deferral amount owed to the plan by the plan sponsor is contingent on how quickly the plan sponsor uncovers and corrects the problem (Revenue Procedure 2015-28 and Revenue Procedure 2013-12). This correction is detailed here.
Including a type of compensation that is not included by the plan’s current definition
The antithesis of the prior error is including compensation that has been excluded from the plan’s definition of compensation. This commonly happens when the plan excludes certain types of compensation that follow the 414(s) exceptions such as bonus, overtime, etc.
The employer contributions, plus their associated earnings, made on the excess compensation should be transferred into the plan’s unallocated forfeiture account. The employee deferrals, plus their associated earnings, should be refunded from the participant’s account.
Now that you have a better idea of why it’s important to choose the right definition of compensation for your benefit plans, it’s time to get to work. Let us know if we can help. Learn more about our benefit plan administration and consulting services here.