Comprehending Compensation John P. Griffin, J.D., LL.M., Principal, ASC Institute, LLC John Griffin, JD, LLM, Principal, ASC Institute, LLC John P. Griffin, J.D. and LL.M. (Taxation), has over 30 years of experience in the employee benefits field. Currently, John is a principal with the ASC Institute (ASCi). Prior to joining ASCi, John was a principal with the pension consulting firm Global Benefit Advisors, LLC (GBA), a Vice President with Pension Publications of Denver, Inc. (PPD) and a senior consultant with the benefit consulting practice of Coopers & Lybrand.
John Griffin, JD, LLM, Principal, ASC Institute, LLC Prior to entering private consulting, John worked in the Employee Plans Division in the National Office of the Internal Revenue Service (IRS) as a Tax Law Specialist. John also has seven years of experience with the U.S. Department of Labor. John is a frequent lecturer and trainer in the employee benefits field. He has spoken at numerous NIPA Annual Forums. AGENDA • Definitions of Compensation • Code §414(s) Compensation • Compensation Limit • Related Employers • Common Plan Defects and Correction Options
COMPENSATIO NSATION N DEFINITI NITIONS ONS Types of Employers • Corporation • S-Corporation • Partnership • Limited Liability Partnership (LLP) • Limited Liability Company (LLC) • Sole Proprietor • Tax Exempt Entity • Governmental Entity
Types of Compensation • Corporation = W-2 • S-Corporation = W-2 • “Pass through” income reported on Form 1120S (Sch. K -1) is NOT self-employment income and NOT plan compensation • Partnership, including LLP • If taxed as partnership = earned income • If taxed as corporation = W-2 • LLC • If taxed as partnership = earned income • If taxed as corporation = W-2 • Sole Proprietor = earned income • Single member LLC Compensation Definitions • Code §415 = Code §415 comp • Top-heavy = Code §415 comp • HCEs = Code §415 comp • Deductions = Code §415 comp • Allocations/accruals = must be defined in Plan Full year or period of participation • • Testing comp = any Code §414(s) definition Full year or period of participation •
Code §415 Compensation • 3 main definitions of compensation • W-2 Compensation • Wages for income tax withholding (Code §3401(a)) • Current includible compensation Can simplified definition that excludes certain types of o “unusual” compensation • For self-employed individuals = use earned income • Sole proprietor = Schedule C • Partners = Form 1065 (Sch. K-1) • Independent contractors = may be self-employed Compensation Definitions Type of Comp W-2 Comp Federal Current Simplified 415 withholding Includible Comp Comp wages (415 Comp) Wages/Salary Included Included Included Included Overtime Included Included Included Included Bonuses Included Included Included Included Commissions Included Included Included Included Tips Noncash tips Same as W-2 Generally Generally and tips under included included $20 per month are excluded
Compensation Definitions Type of Comp W-2 Comp Federal Current Simplified 415 withholding Includible Comp Comp wages (415 Comp) Contributions to Excluded Excluded Excluded Excluded qualified plan (other than elective deferrals) Elective deferrals Included Included Included Included Expense Excluded Excluded Excluded Excluded reimbursement accountable plan Expense Included Included Included Included reimbursement nonaccountable plan Compensation Definitions Type of Comp W-2 Comp Federal Current Simplified 415 withholding Includible Comp Comp wages (415 Comp) “Qualified” moving Excluded Excluded Excluded Excluded expenses “Nonqualified” Included Included Included Excluded moving expenses Nontaxable fringe Excluded Excluded Excluded Excluded benefits Taxable fringe Included Included Included Included benefits Taxable medical or Included Included Included Excluded disability benefits
Compensation Definitions Type of Comp W-2 Comp Federal Current Simplified 415 withholding Includible Comp Comp wages (415 Comp) Group term life Included Excluded Included Included insurance > $50,000 Statutory stock Excluded Excluded Excluded Excluded options - grant or exercise Nonstatutory stock Included Included Included Excluded option includible in year granted Nonstatutory stock Included Included Excluded Excluded option includible in year of exercise Compensation Definitions Type of Comp W-2 Comp Federal Current Simplified 415 withholding Includible Comp Comp wages (415 Comp) Nonqualified plan Excluded Excluded Excluded Excluded contributions Nonqualified plan Included Included Excluded unless Excluded unless distributions plan provides plan provides otherwise otherwise Differential wage Included Included Included Included payments (HEART Act)
Code §415 Compensation • Used for §415, HCE, top heavy and deductions • §415 comp is grossed up for pre-tax deferrals • Cannot simply use Box 1 W-2 compensation since Box 1 does not include pre-tax deferrals Must add back pre-tax deferrals from Box 12 of W-2 o Be careful of Roth contributions since those amounts are included o in Box 1 and Box 12 of W-2 • Must use 12-month measuring period • May not use compensation while a participant Code §415 Compensation • Measuring period is based on purpose for which compensation is being used • Code §415 = limitation year • HCE = lookback year • Top-heavy = plan year • Deductions = e mployer’s tax year • Cannot use accrued compensation • “First few weeks” rule = may include amounts earned during year but not paid until first few weeks of next limitation year • Election must be included in plan document
Post-Severance Comp • Post-severance compensation = may include payments made after severance of employment if: Compensation is regular compensation or payment for unused • sick, vacation or other leave Payment is made by the later of 2½ months after severance • from employment or the last day of the limitation year in which the severance occurs, and The amounts would have been paid and included in 415 comp • if EE had not terminated employment • Severance pay not included in compensation = may not use for deferrals Post-Severance Comp • HEART Act = differential pay included as Code §415 compensation ER need not provide differential pay but if does = included as • 415 compensation o EE treated as employed = must receive top-heavy Can exclude differential pay from Plan compensation = not • subject to 414(s) testing Any contributions made on differential pay need not be taken • into account for nondiscrimination testing • Plan can exclude all post-severance comp for plan purposes Presumably would require 414(s) testing •
Allocation Compensation • Generally, may use any definition of compensation for allocations • Must use nondiscriminatory compensation for: • Uniform allocation safe harbor • Permitted disparity safe harbor • Safe harbor 401(k) contributions • Must use nondiscriminatory definition of compensation when testing plan contributions • To be nondiscriminatory = must meet definition under Code §414(s) Code §414(s) Compensation • For nondiscrimination test (e.g., ADP/ACP test) = must use nondiscriminatory definition of compensation under Code §414(s) • Plan need not define compensation used for testing purposes o If plan does define testing compensation = must follow definition under plan • Start with Code §415 compensation and may exclude any of the following: • All elective deferrals (including Roth contributions) • All fringe benefits, reimbursements, moving expenses, deferred comp and welfare benefits • Amounts payable only to HCE
Compensation Ratio Test • If exclude compensation other than safe harbor exclusions = must pass compensation ratio test Determine compensation % for each EE • plan comp Compensation % = ------------ • total comp Compare average for HCEs and NHCEs • HCE average cannot exceed NHCE average by more than a • “de minimis ” amount 3% difference is generally considered de minimis o Example of Comp Ratio Test • Plan excludes bonuses for purposes of calculating ER contributions Total Plan Comp Comp Avg. EE Comp Comp Ratio Ratio % % HCE1 $260,000 $260,000 260/260 100% HCE2 $260,000 $260,000 260/260 100% HCE3 $200,000 $200,000 200/200 100% 100% NHCE 1 $80,000 $76,000 76/80 95% NHCE 2 $65,000 $63,000 63/65 96.92% NHCE 3 $47,000 $45,000 45/47 95.74% NHCE 4 $42,000 $40,000 40/42 95.24% NHCE 5 $42,000 $41,000 42/42 97.62% NHCE 6 $39,000 $39,000 39/39 100% 96.75% $1,035,000 $1,024,000 Does compensation definition satisfy Code §414(s)?
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