Using an incorrect definition of compensation in your retirement plan can lead to costly operational failures that can affect your plan’s qualified status. Impacted areas may include: Contributions and benefits The contributions and benefits provided by the plan could be wrong if an incorrect definition of compensation is used to calculate them. For example, a plan operational failure will occur when an employer makes profit-sharing contributions using base compensation instead of base compensation plus commissions as required by the plan document’s compensation definition. Nondiscrimination requirements Excluding items of compensation for non-highly compensated employees could be considered discriminatory, while excluding items of compensation for highly compensated employees is never discriminatory. A qualification failure may occur if the plan excludes overtime (or other) pay from its definition of compensation resulting in non-highly compensated employees receiving a lower contribution rate than highly compensated employees. Employer’s deduction for plan contributions A nondeductible contribution may result if the employer uses a higher amount of compensation than that allowed under the Internal Revenue Code (see Code Section 404.) The employer may owe additional tax including excise taxes on the excess (see Code Section 4972 and Pub. 560 - Excise taxes.) Highly compensated or key employees, plan limits and top-heavy minimum benefits The plan will have a qualification failure unless it uses the statutory definition of compensation for these limits and minimums (see Code Sections 415 and 416.) Tips to avoid compensation-related failures Review your plan document’s definitions of compensation for each plan purpose. Use the statutory definition of compensation when required. Transmit accurate compensation data for each employee to your payroll processor and plan administrator. Consider amending your plan to use one definition of compensation for all plan purposes. Periodically review your plan for errors and fix them as quickly as possible using IRS correction programs.