Compensation Issues – Revisited

Posted by Chris Ciminera, CPA, QKA

Compensation Issues - Delaware 401k AuditWe have completed another retirement plan audit season and have noticed a number of common errors occurring with compensation. I previously discussed these issues in my blog series “Compensation: The Missing Link – Part 1” and “Compensation: The Missing Link – Part 2,” but we want to revisit the issue, since we are seeing this error occur on a rather consistent basis. Additionally, the IRS has indicated that not following the plan’s definition of compensation is one of the top reasons for errors in the administration of retirement plans.

The issue is that plan sponsors will generally exclude certain payments to employees from eligible plan compensation when their plan document specifies that all compensation is included in the definition of eligible compensation. If a plan sponsor intends not to make deferral withholdings from a specific type of pay, then that compensation category must be specifically excluded in the plan document. The following are more common types of payments that we have seen being excluded from eligible compensation:

  • Fringe Benefits (taxable auto allowances, achievement awards, educational assistance, moving, etc.)
  • Bonuses
  • Commissions
  • Overtime

Additionally, we have recently seen other nontraditional payments made by employers being excluded from eligible compensation:

  • Domestic Partner Benefits
  • Tax Assistance
  • Taxable Relocation Bonus
  • Performance-Based Earnings
  • Retroactive Pay
  • Miscellaneous Pay

In practice, all of these items might not be coded in the payroll system as wages from which deferral withholdings will be taken because the plan sponsor or the payroll person doesn’t view them as eligible plan compensation. For example, a plan sponsor generally does not intend to withhold deferrals from an annual holiday gift card; however, if this amount is taxable income included in the employee’s W-2, and the definition of plan compensation is defined as gross compensation, which includes all taxable income reported on the W-2, then the sponsor should be withholding deferrals from the value of the holiday gift card. The solution is simple. Holiday gift cards can be easily excluded from the definition of compensation if that is the plan sponsor’s intention.

Our recommendation is for plan sponsors to review the plan document thoroughly with the assistance of their third-party administrator, ERISA counsel, or their auditor to verify that the plan document is correctly excluding payments that are not intended to be included in the definition of eligible compensation. The plan document should be amended to specifically exclude any payment categories that the sponsor intends to exclude. When it comes to plan compensation, a plan sponsor must know what the plan document says and then follow it.

Photo by Scott Waldron (License)