Information For...

For you and your family
Individuals abroad and more
EINs and other information

Filing For Individuals

Information For...

For you and your family
Standard mileage and other information

Forms and Instructions

Individual Tax Return
Request for Taxpayer Identification Number (TIN) and Certification
Single and Joint Filers With No Dependents
Employee's Withholding Allowance Certificate

 

Request for Transcript of Tax Returns
Employer's Quarterly Federal Tax Return
Installment Agreement Request
Wage and Tax Statement

Popular For Tax Pros

Amend/Fix Return
Apply for Power of Attorney
Apply for an ITIN
Rules Governing Practice before IRS

Compensation Definition in Safe Harbor 401(k) Plans

Safe harbor 401(k) plans must use a definition of compensation that complies with IRC Section 414(s). This Snapshot explores some aspects of IRC Section 414(s) and other compensation issues that are pertinent to safe harbor 401(k) plans.


IRC Sections and Treas. Regulations

Resources

  • 2011 CPE, Chapter 12, Safe Harbor Plans
  • 2013 Phase II Training, Chapter 8, Compensation
  • 2015 Winter CPE, Compensation PowerPoint

Analysis

A safe harbor 401(k) plan is exempt from many of the compliance requirements applicable to traditional 401(k) plans, such as ADP testing, provided it meets certain rules.

One such rule is that plan benefits and contributions must be based on a nondiscriminatory definition of compensation within the meaning of IRC Section 414(s). See IRC Section 401(k)(9), Reg. Section 1.401(k)-3(b)(2) and 1.401(k)-6.

Section 414(s) compensation

Some definitions of compensation automatically satisfy IRC Section 414(s). For example, a definition of compensation that includes all compensation within the meaning of IRC Section 415(c)(3) and excludes all other compensation automatically satisfies IRC Section 414(s). See Reg. Section 1.414(s)-1(c)(2).  A definition of compensation within the meaning of IRC Section 415(c), with certain permissible modifications, also satisfies IRC Section 414(s). See Reg. Section 1.414(s)-1(c)(3), (4) and (5).

In addition, a definition of compensation within the meaning of IRC Section 415(c)(3) modified to exclude certain amounts that would be includible in gross income but for an election by the employee (such as elective deferrals) satisfies IRC Section 414(s).

Finally, any other definition of compensation generally satisfies IRC Section 414(s) if the definition meets three criteria:

  1. it does not by design favor highly compensated employees, 
  2. it is reasonable within the meaning of Reg. Section 1.414(s)-1(d)(2), and 
  3. it satisfies the nondiscrimination requirement set forth in the regulations. See Reg. Section 1.414(s)-1(d).  

Examples

  1. A safe harbor 401(k) plan defines compensation as Form W-2 wages (that is, the amount shown in an employee’s W-2, Box 1, Wages, tips, other compensation), less reimbursements, fringe benefits, moving expenses, and welfare benefits. This definition satisfies IRC Section 414(s) because it complies with Reg. Section 1.414(s)-1(c)(3).
  2. A safe harbor 401(k) plan excludes overtime and bonuses from the definition of compensation. The definition will satisfy IRC Section 414(s) if it (i) does not by design favor highly compensated employees, (ii) is reasonable within the meaning of Reg. Section 1.414(s)-1(d)(2), and (iii) satisfies the nondiscrimination requirement set forth in Reg. Section 1.414(s)-1(d)(3).

Cap on compensation for non-highly compensated employees not permitted

For purposes of the “reasonable” element in determining if a definition of compensation meets the requirements of IRC Section 414(s), a plan may not exclude compensation in excess of a specific amount for non-highly compensated employees. See Reg. Section 1.401(k)-3(b)(2), and Reg. Section 1.414(s)-1(d)(2)(iii).

For example, a safe harbor 401(k) plan may not take into account only 90% of a non-highly compensated employee’s IRC Section 415(c) compensation. This is not the case for a non-safe harbor 401(k) plan where compensation for non-highly compensated employees may be defined as limited to a specific amount. See Reg. Section 1.414(s)-1(d)(2)(iii). 

Compensation may be limited to period of eligibility

Compensation in a safe harbor 401(k) plan may either be limited to an eligible employee’s period of participation or be for the entire plan year even though the employee only participated for part of the year. See Reg. Section 1.401(k)-3(b)(2) (last sentence). 

For example, Susan becomes a participant in a safe-harbor 401(k) plan on September 1, 2016 with a 3% non-elective employer contribution. The plan year is the calendar year. The plan can provide that the 3% non-elective employer contribution will be based on Susan’s compensation for the period of September 1, 2016 to December 31, 2016. Alternatively, the plan can provide that the 3% non-elective employer contribution will be based on Susan’s compensation for 2016. The provision must be applied uniformly to all employees.  

Audit Tips

Examine the plan document, adoption agreement and all amendments to determine and document in your work papers the various definitions of compensation for, but not limited to:

  1. Calculating contributions and deferrals.
  2. Calculating the dollar amounts reported under the various definitions of compensation.
  3. Using the payroll reports, a source document, to confirm the accuracy of the Forms W-2, a non-source document.
  4. Verifying the correct definition(s) of compensation are used for contributions and deferrals.