Qualified Retirement Plan Definition of Compensation: More Complicated Than You Would Think

Safe Harbor Adjustments (Part 2 of 3)

(click here to see Part 1)

IRC 414(s) Definitions of Compensation

The four definitions of compensation described in the previous article are acceptable definitions of compensation for IRC 414(s) in addition to IRC 415(c). IRC 414(s) compensation is used in allocating certain contributions and performing certain non-discrimination tests. There are three broad definitions of compensation under IRC 414(s):

  • The four definitions of compensation described above under IRC 415(c)
  • Safe harbor adjustments to the IRC 415(c) definitions
  • A reasonable definition of compensation that does not favor highly compensated or key employees

IRC 415(c) Compensation

All four of the definitions of compensation described above under 415(c) are applicable under IRC 414(s).

Safe Harbor Adjustments to IRC 415(c) Compensation

There are three modifications to the definition of compensation that are safe harbors for 414(s) compensation:

  • The following are excluded from 415(c) compensation:
    • Qualified moving expenses
    • Accountable expense reimbursements and allowances
    • Taxable cash and/or non-cash fringe benefits
    • Welfare benefits
    • Deferred compensation
  • The following are added to 415(c) compensation:
    • Compensation deferred under a 457(b) plan
    • Elective deferrals not included in gross income under sections 125, 402(e)(3), 402(h) and 403(b)
    • Employee contributions to governmental plans under section 414(h)(2) that are treated as employer contributions
  • Exclude any form of compensation to highly compensated employees only
    • This safe harbor adjustment can be combined with either of the previous two safe harbor adjustments or stand alone

Alternative Definition of 414(s) Compensation

There is one final definition that is applicable under IRC 414(s). This non-safe harbor compensation must satisfy each of the following three requirements:

  • Does not discriminate against non-highly compensated employees
  • Is considered reasonable
    • Excluded compensation is outside of the normal work scheduled
    • Definition excludes any or all of the following:
      • Overtime
      • Bonus
      • Commissions
      • Premiums for shift differential
      • Call-in premiums
      • Elective deferrals or deferred compensation
      • Any of the excluded types of compensation from the first 414(s) safe harbor listed above
      • Compensation above a defined ceiling
    • Passes the “compensation ratio nondiscrimination test” (IRC 1.414(s)-1(d)(1)

The definition of compensation for a retirement plan is one of the plan sponsor’s most important decisions and one of the easiest to misinterpret. The four 415(c) definitions are similar in many ways and these similarities can lead to misinterpretation and operational failures for the plan. Plan sponsors should review their definition of compensation and ensure that their payroll software accurately includes and excludes the forms of compensation that the plan dictates. This is especially important when changing payroll providers, undergoing large software updates and amending or restating the plan’s adoption agreement. Ensuring that the plan’s definition of compensation is accurately followed is a fiduciary responsibility that will help the plan and its plan sponsors remain in compliance with IRS and DOL regulations.

 

 

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