3729 / What is counted as compensation for purposes of applying the Section 415 limits to defined contribution plans?

Compensation to which the limit is applied is the compensation for the limitation year from the employer maintaining the plan.¹ It includes wages, salaries, fees for professional services, and other amounts for services actually rendered (such as commissions, percentage of profits, tips, and bonuses).² Compensation also includes (i) elective deferrals to 401(k) plans, SAR-SEPs, SIMPLE IRAs, and Section 457(b) plans to the extent not includable in the employee’s income and (ii) any amounts contributed or deferred by the election of the employee and excluded from gross income of the employee under IRC Sections 125 (cafeteria plans), 132(f) (qualified transportation fringe benefit plans), or 457 (deferred compensation plan of a government or tax-exempt organization).³ The foregoing items may be used as a simplified safe harbor definition of compensation.⁴

The regulations also permit the following to be included as compensation to the extent they are includable in the gross income of the employee: certain payments received under an employer’s accident and health plan, certain moving expense reimbursements, the value of nonqualified options in the year granted, and certain property transferred in connection with the performance of services.⁵

In the case of a self-employed person, his earned income is compensation.⁶

The SECURE Act also modified the definition of compensation so that certain stipends provided to graduate students can be counted as compensation for IRA contribution purposes after December 31, 2019. Similarly, qualified foster care payments (excluded from income) can be treated as compensation for plan years effective after December 31, 2015 (retroactively) for defined contribution plans and after 2019 for IRAs.⁷

Except as noted above, compensation does not include nontaxable employer contributions toward deferred compensation plans, qualified or nonqualified, in the year in which they were contributed. Furthermore, deferred compensation distributions are not compensation when received whether or not excludable from gross income, except that distributions of unfunded nonqualified deferred compensation may be considered compensation in the year in which they are includable in gross income.⁸ Excludable premiums for group term life insurance are not compensation.⁹ Foreign source income generally will be treated as compensation even though excluded from gross income.¹⁰

The compensation must be actually paid or made available to be taken into account within the limitation year.¹¹ Compensation includes compensation from all employers that are members of a controlled group of corporations or a group of trades or businesses under common control.¹² Regulations also provide for safe harbors based on wages for income tax withholding or wages as reported in Box 1 on Form W-2.¹³

Post-severance compensation of the following amounts is included as compensation if paid within 2½ months following severance from employment: (1) payment for unused sick or vacation leave the employee could have used had employment continued or (b) amounts that would have been paid had employment continued, such as compensation and overtime, commissions, bonuses, or similar compensation. It should be noted that this treatment will not apply to other types of post-severance packages, such as parachute payments under IRC Section 280G and unfunded nonqualified deferred compensation.¹⁴