What is Compensation?

[richard]

It is typical in an S Corporation and now in LLCs for the owner to take a W2 salary from the corporation, "leave some money" in the corporation at the end of the year, and this amount is included on his 1040 as a corporate distribution or dividend (I'm not sure of the exact term).

Does this "corporate distribution or dividend" count for various definitions of compensation which affect retirement plans.

For example:

Assume the owner's W2 is $25,000 and his "dividend" is $20,000. (Use higher numbers if you would like.)

1. For the 415 limit on DC and DC plans, do we use a pay of $25,000 or $45,000?

2. For the compensaton used in the denominator of the 401(a)(4) tests, do we use $25,000 or $45,000?

3. For the compensation used in the denominator of the ADP/ACP test in a 401(k) plan, do we use $25,000 (plus his deferral)or $45,000 (plus his deferral)?

4. For testing in a 401(k) plan against the 25% of pay limit, do we use $25,000 (plus his deferral) or $45,000 (plus his deferral)?

5. For determining the 15% of compensation company-wide profit sharing contribution limit, do we use $25,000 or $45,000?

If we define "compensation" in the plan to include this "corporate distribution or dividend", does this help?

Does it make a difference whether the company is an S Corporation or an LLC?

[Ervin Barham]

I had this question come up several years ago. For purposes of retirement calculation (all of them), you would only use the W-2 income. Since most plans (at least the ones I'm familiar with) define comp as "earned income", the dividend would not count since that is not considered earned income.

I can't really answer your question on amending the comp definition, but somehow I don't think that is possible. I don't have a cite.

And no, it doesn't matter if this is an LLC or partnership. Both are treated for plan purposes as a partnership.

[Guest Dan Ashley]

Richard, Ervin is right. This is a major trap for the unwary.

[Guest Mike Kimball]

I agree with the above. When testing several 401(k) plans for 1998 (their first year),I had a few s-corps that were thinking they could defer a substantial amount and still only draw a W-2 of 40-50,000. Boy did they get a surprise when the ADP failed! [bTW these are clients brought to us for admin after being sold by someone else in various parts of the country. We never had opportunity to advise them properly!].