6. Definition of compensation

Statement of Requirement: Code §§ 414(s), 401(a)(17), 415(c)(3); Reg. §§ 1.401(a)(4)-12, 1.401(a)(17)-1, 1.414(s)-1, 1.415(c)-2; Rev. Proc. 2023-37, 2023-51 I.R.B. 1491, secs. 9.03(3) & 12.02(4); Notice 2010-15, 2010-6 I.R.B. 390; Notice 2020-68, 2020-38 I.R.B. 567

(Note to reviewer: Standardized Pre-approved Plans that include nonelective employer contributions must define compensation, for allocation purposes, as total compensation. Total compensation means a definition of compensation that includes all compensation within the meaning of Code § 415(c)(3) or compensation that otherwise satisfies Code § 414(s) and Reg. § 1.414(s)‑1(c).

Nonstandardized Pre-approved Plans may allow the employer to elect an alternative definition of compensation, provided that, for purposes of determining the amount of nonelective employer contributions, compensation is limited pursuant to Code § 401(a)(17). A Nonstandardized Pre-approved Plan may, but is not required to, use any of the definitions of compensation below.)

Sample Plan Language:

Compensation will mean compensation as that term is defined in section ____ of the plan. For any self-employed individual covered under the plan, compensation will mean earned income. Except as provided elsewhere in this plan, compensation shall include only that compensation which is actually paid to the participant during the determination period, and the determination period shall be the period elected by the employer in the adoption agreement. If the employer makes no election, the determination period shall be the plan year.

(Note to reviewer: The blank should be filled in with the plan section number that corresponds to Option B of the sample adoption agreement language at the end of LRM #31.)

(Note to reviewer: Under certain circumstances, other definitions of compensation may be used. However, compensation in Standardized plans and in determining top-heavy minimums must use one of the definitions provided in section 4.2 of LRM #31. For purposes of the preceding sentence, the safe harbor alternative definition of compensation contained in Reg. § 1.414(s)-1(c)(3) may also be used. A plan will not fail to be a Standardized plan if it uses a definition of compensation approved for Standardized plans but excludes from that definition differential wage

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payments under § 3401(h). See Notice 2010-15, Q&A-10.

All Standardized plans require the employer to elect one of the definitions of compensation provided in section 4.2 of LRM #31 in the adoption agreement. Each Nonstandardized Plan may provide the Adopting Employer the option to select total compensation as the compensation to be used in determining allocations or benefits. See also LRMs #62, #89 and #93.)

Notwithstanding the above, if elected by the employer in the adoption agreement, compensation shall not include any amount which is contributed by the employer pursuant to a salary reduction agreement and which is not includible in the gross income of the employee under sections 125, 132(f)(4), 402(e)(3), 402(h)(1)(B) or 403(b) of the Code.

The annual compensation of each participant taken into account in determining allocations shall not exceed $330,000, as adjusted for cost-of-living increases in accordance with section 401(a)(17)(B) of the Code for periods after January 1, 2023. Annual compensation means compensation during the plan year or such other consecutive 12-month period over which compensation is otherwise determined under the plan (the determination period). The cost-of-living adjustment in effect for a calendar year applies to annual compensation for the determination period that begins with or within such calendar year.

(Note to reviewer: IRC § 401(a)(17) limits compensation taken into account to $200,000 in determining contributions and allocations and provides that this limit will be adjusted each year for cost-of-living increases. The limit for 2023 is $330,000. See IRS News Release IR-2022-188. For limits in other years, see COLA Increases for Dollar Limitations on Benefits and Contributions.)

If a determination period consists of fewer than 12 months, the annual compensation limit is an amount equal to the otherwise applicable annual compensation limit multiplied by a fraction, the numerator of which is the number of months in the short determination period, and the denominator of which is 12.

If compensation for any prior determination period is taken into account in determining a participant's allocations for the current plan year, the compensation for such prior determination period is subject to the applicable annual compensation limit in effect for that prior period.

Sample Adoption Agreement Language:

Compensation shall be determined over the following determination period:

( ) the plan year

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( ) a consecutive 12-month period ending with or within the plan year beginning: _____ (day) _________ (month). For employees whose date of hire is less than 12 months before the end of the 12-month period designated, compensation will be determined over the plan year.

(Note to reviewer: The plan may provide that compensation will be determined over the period of plan participation during the plan year, as provided in Reg. § 1.401(a)(4)-12. See paragraph 4 of the definition of "plan year compensation" in Reg. § 1.401(a)(4)-12.)

(Note to reviewer: Designated Roth matching contributions and designated Roth nonelective contributions are not wages as defined in §§ 3401(a) or 3121(a); therefore, they are not included for purposes of purposes of federal income tax withholding, FICA or FUTA taxation. To the extent that plan language defines any of the following electable compensation definitions with respect to these amounts, plan terms should be revised or otherwise note this change. See Q&A-5, -6, and -7 of Notice 2024-2. See also DC LRM #31 regarding compensation for § 415 purposes and the CODA LRM for additional content in this regard.)

Compensation will mean all of each Participant's:

( ) Wages, tips, and other compensation as reported on Form W-2.

( ) Section 3401(a) wages.

( ) 415 safe-harbor compensation (as defined in section 1.415(c)-2(d) of the Treasury Regulations), which includes contributions (other than Roth Elective Deferrals) made pursuant to a Compensation Reduction Election which are not includible in the gross income of the participant under section 125, 132(f), 402(e)(3), 402(h)(1)(B) or 403(b) of the Internal Revenue Code.

(Note to reviewer: Code § 3401(h) provides that a differential wage payment shall be treated as a payment of wages under Code § 3401(a) for a payment made after December 31, 2008. Similarly, Code § 415(c)(8) provides all plans must include difficulty of care payments in a participant’s compensation for purposes of calculating the annual additions limit of Code § 415(c)(1). See Notice 2020-68, Section E.)

( ) Check here if the Employer chooses to exclude contributions (other than Roth Elective Deferrals) made pursuant to a Compensation Reduction Election which are not includible in the gross income of the participant under section 125, 132(f), 402(e)(3), 402(h)(1)(B) or 403(b) of the Code.

( ) Check here if the Employer chooses to include deemed section 125 compensation (as defined in § 1.415(c)-2(g)(6) of the Treasury Regulations) for purposes of the definition of Compensation.

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( ) Check here if the Employer chooses not to include deemed section 125 compensation (as defined in section 1.415(c)-2(g)(6) of the Treasury Regulations) for purposes of the definition of Compensation.