Beware Mismatched Definitions of ‘Compensation’

There are many reasons that errors in plan operation may take place. An industry expert lays some of the blame on disconnection between the way a plan defines compensation and the way it functions.

Christine P. Roberts, a benefits attorney practicing at Mullen & Henzell, LLP, in the E is for ERISA blog says that disconnect generates “a significant number” of operational failures. 

Such errors, Roberts writes, include: 

• Adding payroll codes to a system without applying participants’ deferral elections and employer contribution to those payroll amounts. 
• Carving out categories such as bonuses, commissions and overtime from a plan’s definition of compensation, without stopping deferrals and employer contributions from those amounts.  
• Overlooking categories of pay, such as tips recorded on credit cards. 
• Confusion over the scope of categories referred to in the safe harbor definitions of compensation, such as nontaxable fringe benefits and differential wage payments.  

Action Steps 

Roberts suggests some steps that can be taken to avoid such mismatches. These include:

Remember that certain pay items—for instance, cash and/or non-cash fringe benefits, reimbursements, expense allowances and moving expenses—may be excluded from “safe harbor” definitions of compensation; however, exclusions such as overtime will trigger the need to perform annual testing of the definition of compensation under nondiscrimination rules. 

Holding an annual meeting in which human resources and payroll personnel compare the definition of compensation in the adoption agreement and the payroll codes in use. Roberts adds that such a comparison could be helpful when:

• payroll practices are modified;
• there is a change in payroll practices, vendors or software; and 
• if the plan’s definition of compensation changes. 

If a plan defines compensation in a way that involves carve-outs, act to ensure that salary deferrals and employer contributions are not applied to the payroll code amounts that correspond to the exclusions—such as bonuses, commissions and overtime.