Plan compensation

What plan compensation is

Most plans start from one of three definitions: Form W-2 wages, wages subject to federal income tax withholding, or the “section 415” safe harbor definition. A plan can exclude items such as bonuses, overtime or commissions, but an exclusion used for testing or safe harbor contributions has to be nondiscriminatory. The plan also says whether pay counts for the full year or only from the date the employee entered. In 2026 only the first $360,000 of pay can be counted.

For 2027 the cap rises to $375,000. (IRS Notice 2026-66)

Why it matters to employers

Payroll applies deferral elections and match formulas to pay codes, so every pay code has to be mapped to the plan’s definition. When payroll and the document disagree, employees get too little or too much, and the employer has to correct it.

Example

A plan defines compensation as W-2 wages, including bonuses. An employee has a 5% deferral election, but payroll does not apply it to her $10,000 bonus. The missed deferral is $500, and the match on it is missed too. The employer owes a corrective contribution with earnings.

Common mistakes

• Adding a new pay code in payroll without mapping it to the plan.

• Leaving out bonuses or overtime in practice when the document includes them.

• Not applying the $360,000 limit to highly paid employees.

• Using full-year pay when the document counts pay only from the entry date.