How do we handle owners with Schedule C or K1 income when it comes to providing compensation information on the annual census request OR for purposes of participating in the 401(k) plan?
For most plans that use the W-2 definition of compensation, compensation includes all earned income. This includes Schedule C and K1 income.
Please note, for inclusion in the compensation, the K1 must be compensation from employer (remuneration for services performed). No portion of the compensation can include reportable items such as a return on investment.
For sole proprietors the income and expenses are reported in Schedule C of the sole proprietors individual tax return. Income to the sole proprietor is the net schedule C income, expenses include:
- Contributions to a pension or profit sharing plan for the benefit of your employees
- Social security and medicare taxes paid to match the required withholding of employee wages
Should the employee's reported compensation on the annual census include the elective deferrals or other salary reduction amounts?
Yes, we want gross compensation. A couple of ways to look at:
- W-2 Box 1 plus all deferrals (including Section 125 plans) - Box 1 does not include deferrals
- W-2 Box 5 plus Section 125 deferrals/salary reduction - Box 5 includes 401(k) deferrals but not Section 125 deferrals/salary reduction
What are the definitions of compensation?
We could write a book on this question (in fact, I believe someone has). This answer is strictly written at the macro level. As always, contact your ERISA Consultant or attorney for plan specific questions.
415 Compensation - This definition is important as it applies to identifying HCE's and key employees (as well as calculating the minimum required top heavy contribution). 415 compensation has three potential definitions:
- W-2 (6051) - Self explanatory and the most common 'safe harbor' definition used by plan sponsors. Please do not get confused with the word 'safe harbor' as it is used often in the regulations.
- Current includable compensation - Compensation includes all wages, salaries, and other amounts related to providing services to the employer (limited to includible in gross income). This definition includes overtime, bonuses, tips, fringe benefits, commissions, 1099 (if applicable, such as a sole prop who gets paid by a client via 1099)and certain reimbursements.
- Wages for income tax withholding (Secton 3401(a) wages) - Similar to W-2 definition with a few exclusions, such as the housing allowance for ministers, certain reimbursements, third party sick pay, and workers compensation to name a few.
414(s) Compensation - This definition is used for all nondiscrimination tests and permitted disparity formula's. The good news, is any 415 compensation definitiona defined above is a safe harbor definition for 414(s).
Are car expenses included in compensation?
The answer is dependent upon whether the client has an arrangement that would be considered an "accountable plan" or a "nonaccountable plan" under Treas. Reg. 1.62-2(c). Please note, the ‘plan’ is related to the accounting arrangement not the qualified plan document.
Typically the the plan sponsor's accountant answers the question of whether or not the arrangement is an accountable plan. In a nutshell for the car expense:
- Accountable Plan – Not included in compensation
- Nonaccountable Plan – Included in compensation
Payments made under an accountable plan are not reported as wages or other compensation on the W-2, are not subject to withholding, FICA or FUTA, etc.
Are bonuses included in compensation?
The bonus is typically included in the definition of compensation (not to be confused with the ability to defer on these amounts as that answer is plan document driven).
The content of this website is general in nature and is for informational purposes only. It should not be used as a substitute for specific tax, legal and/or financial advice that considers all relevant facts and circumstances.