Understanding the definition of compensation for the purposes of your 401(k) plan is important because it is used to calculate employee deferrals, matching contributions, profit sharing allocations and is used to perform required nondiscrimination testing.
For purposes of your Guideline 401(k) plan, compensation is defined as the amount your company pays an employee during the calendar year that is subject to individual income taxes. Amounts paid to contractors are not included in compensation. In most cases, if you are paying taxes on the amount it will be included in your compensation under the Guideline Plan. This definition of compensation in your plan document cannot be deviated from; however, an employee can adjust their contribution deferral rate at any time. See this article to learn more about self-employed owner or partner compensation or below for a breakdown of common compensation types:
Chart of includible compensation under the Guideline Plan: (1)
|Compensation type||Included in the definition of compensation for employee deferrals?||Included in the definition of compensation for employer contributions?||Details|
|Salary||Yes.||Yes, though amounts earned prior to becoming eligible to participate in the plan, and amounts over the annual compensation limit are usually excluded. (2)||This is salary paid during the applicable tax year.|
|Bonus, commission, tips||Yes.||Yes.||Yes.|
|401(k) salary deferrals||Yes.||Yes.||Salary deferrals to your 401(k) are included in your compensation. Deferring more into your 401(k) does not reduce your compensation.|
|Taxable fringe benefits||Yes.||Yes.||These include things like fitness stipends and personal use of a company vehicle that are reported as income on your W-2.|
|Nontaxable fringe benefits||Yes.||Yes.||These include things like transportation subsidies or meals at the office and are not included as income.|
|Health insurance||Only for greater than 2% S-Corp owners.||Same as employee deferrals.||Generally health insurance is not taxable, except for S-Corp owners who must report health insurance in W-2 income.|
|Post-Employment Compensation||Yes. Compensation for work performed that is paid within 2 ½ months is included, but severance pay unrelated to work performed is not.||Same as employee deferrals.||Compensation paid for services performed, including commissions and bonuses, unused accrued sick, vacation, or other leave are included in gross income.|
|Compensation in excess of $280,000 for 2019 Plan years ($285,000 in 2020)||Included for deferrals; but excluded for non-discrimination testing purposes.||
Compensation over $280,000 is not eligible for employer contributions.
This amount must generally be prorated for plan years less than 12 months.
|Even when some of the compensation is over limits and is not includable, Guideline should receive total compensation for each individual.|
|Compensation earned prior to becoming eligible to participate in plan||Deferrals can only be made from income you earn after you become eligible.||Matching and non- elective safe harbor contributions will be calculated based on compensation earned while a participant in the plan.||Profit sharing and matching limits are based on Plan Year compensation.|
(1) This chart is intended to provide general information about the Guideline plan provisions, it is not intended to be tax or legal advice. As always, if you have specific questions about your situation you should consult your tax advisor.
(2) Generally, this amount is excluded. However, in the first year the plan is in existence, there is a plan election that when used will allow the full year's compensation to be used while in all other plan years compensation prior to participation must be excluded. For short plan years, you can only use compensation earned in the short plan year.