Chapter 4: Compensation

Question 1

IRC §415 compensation must include elective deferrals to a 401(k) plan.

True or False?

Answer 1

True

Question 2

The average percentage of total compensation that is considered for NHCEs must be at least 70 percent of the average percentage of total compensation considered for HCEs in order for the definition of compensation to satisfy IRC §414(s).

True or False?

Answer 2

False. If the definition of compensation does not satisfy one of the IRC §414(s) safe harbors, the average percentage of total compensation that is considered for HCEs cannot exceed the average percentage of total compensation for NHCEs by more than a de minimis amount.

Question 3

The plan’s definition of compensation used for allocating contributions must satisfy the nondiscriminatory definition of compensation under IRC §414(s).

True or False?

Answer 3

False. IRC §414(s) compensation must be used to determine if the contributions are nondiscriminatory. However, a plan is not required to use a definition of compensation that satisfies IRC §414(s) in calculating the amount of contributions provided in the plan.

Question 4

IRC §414(s) compensation must include elective deferrals to a 401(k) plan to avoid testing that definition for nondiscrimination.

True or False?

Answer 4

False. Elective deferrals may be excluded from the definition of IRC §414(s) compensation as a safe harbor, so long as all elective deferrals (i.e., 401(k), 403(b), Roth, and 125 Plan) are treated the same.

Question 5

IRC §415 compensation must be used to determine HCEs.

True or False?

Answer 5

True

Question 6

IRC §414(s) compensation must be used to determine key employees.

True or False?

Answer 6

False. IRC §415 compensation must be used to determine key employees.

Question 7

IRC §415 compensation must not include tips, depending on how IRC §415 compensation is defined.

True or False?

Answer 7

False. IRC §415 compensation may include some tips

Question 8

Designated Roth contributions are included in IRC §415 compensation.

True or False?

Answer 8

True. Care must be taken that designated Roth contributions are not counted twice, due to how these contributions are reported on Form W-2.

Question 9

Excluding nontaxable fringe benefits from IRC §415 compensation is a safe harbor modification to IRC §414(s) compensation, meaning the resulting definition will not need to be tested for nondiscrimination purposes.

True or False?

Answer 9

False. None of the definitions include nontaxable fringes. They only include taxable fringe benefits.

Question 10

IRC §415 compensation is based on the plan year.

True or False?

Answer 10

False. IRC §415 compensation is based on a limitation year, which may or may not be the same as the plan year.

Question 11

Which of the following statements regarding IRC §414(s) compensation is NOT TRUE?

A. A plan using a safe harbor definition of IRC §414(s) compensation for nondiscrimination testing need not perform the compensation ratio test.
B. A plan using a nonsafe harbor definition of IRC §414(s) compensation for nondiscrimination testing must apply such definition consistently for all participants.
C. A plan may meet the safe harbor definition of IRC §414(s) compensation by including 401(k) elective deferrals and excluding 125 plan elective deferrals.
D. A plan may use a 12-month period other than the plan year for purposes of determining IRC §414(s) compensation.

Answer 11

C. The treatment of deferrals (including those for 401(k) and 125 plans) must be consistent, either all included or all excluded, for the definition to meet the safe harbor requirements.

Question 12

Which of the following exclusions are not deemed reasonable for defining IRC §414(s) compensation?

A. 20 percent of regular compensation
B. Bonuses
C. Overtime
D. Expense allowances

Answer 12

A. Percentages of compensation are not deemed reasonable exclusions for IRC §414(s) purposes.

Question 13

Which of the following is not included in compensation under IRC §415?

A. Elective deferral
B. Expense reimbursements paid under an accountable plan
C. Bonuses
D. Overtime

Answer 13

B. Expense reimbursements paid under an accountable plan are excluded form IRC §415 compensation.

Question 14

Based on the following information, determine the participant’s IRC §415 compensation:
*The employer sponsors a 401(k) plan that allows designated Roth contributions.
*The plan excludes overtime for allocation purposes.
*The participant’s taxable income, not including elective deferrals, is $58,000.
*The participant defers $4,000 as pre-tax elective deferrals and $4,000 as designated Roth contributions.
*The participant defers $500 into the employer’s IRC §125 plan.
*The participant’s overtime compensation totals $3,000.

A. $58,000
B. $59,500
C. $62,500
D. $66,500

Answer 14

C. The participant’s taxable income of $58,000 plus 401(k) elective deferrals of $4,000 and 125 plan elective deferrals of $500 equals $62,500. The designated Roth contributions would already be included in the $58,000 reported on the W-2.

Question 15

Which of the following statements regarding the calculation of the employer deduction is/are TRUE?
1. In the case of a short taxable year, the deduction limit for a defined contribution plan is applied to aggregate participant compensation paid for the short period.
2. A short taxable year results in a prorated compensation dollar limit under IRC §401(a)(17).
3. A short plan year does not directly affect the defined contribution deduction limit because that deduction limit is based on participant compensation for the employer’s taxable year.

A. 2 only
B. 1 and 2 only
C. 2 and 3 only
D. 1, 2, and 3

Answer 15

D. The definition of compensation used by a plan for allocation purposes is irrelevant in determining compensation for deduction purposes. For example, even if a profit-sharing plan excluded bonuses to determine a participant’s share of employer contributions, the bonuses are still included in compensation to calculate the employer’s deduction limit.

Question 16

Which of the following does not describe when a plan’s definition of compensation is subject to nondiscrimination testing?

A. The plan defines IRC §414(s) compensation as IRC §415 compensation excluding elective deferrals to a cafeteria plan and including elective deferrals to a 401(k) plan.
B. The plan defines IRC §414(s) compensation as IRC §415 compensation excluding commissions for HCEs only.
C. The plan defines IRC §414(s) compensation as IRC §415 compensation excluding overtime.
D. The plan defines IRC §414(s) compensation as IRC §415 compensation excluding bonuses.

Answer 16

B. A plan may use IRC §415 compensation and exclude an item of compensation that applies only to HCEs when it defines compensation for IRC §414(s) nondiscrimination purposes.

Question 17

Based on the following information, determine the combined plan deduction:
*The employer sponsors a profit-sharing and a defined benefit plan.
*The defined benefit plan is not covered by the PBGC.
*The employer makes a contribution to the defined benefit plan in the amount of $250,000 which meets the minimum funding requirements.
*The employer makes a contribution to the profit-sharing plan of $30,000.
*Compensation for all eligible employees is $600,000.

A. $30,000
B. $36,000
C. $250,000
D. $280,000

Answer 17

D. An employer who sponsors a defined benefit plan, not covered by the PBGC, and a defined contribution plan is subject to the combined plan limit if the amount contributed to the defined contribution plan is more than 6% of aggregate compensation. In this question, the amount contributed to the defined contribution plan is less than 6% ($600,000 *.06 = $36,000) thus the combined plan limit does not apply. The deduction amount is $280,000 ($250,000 for the defined benefit plan + $30,000 for the profit-sharing plan.)