Disability pay on the W-2

[Belgarath]

Employee was disabled for several months in 2004. Employer has a disability pay program where employer pays all premiums, ins company pays money to employer, and employer pays the disabled individual. This "compensation" is reported by the employer on a W-2.

Plan defines compensation as W-2. Question was, can this be used toward deferrals in a 401(k) plan, and toward the employer discretionary contribution?

Not sure on this. Rightly or wrongly, since the plan definition is W-2, then it seems it must be considered. But, it seems odd. Any opinions? Thanks.

[GBurns]

It should not seem odd, after all, another name for such a program could be Salary Continuation Plan, couldn't it? As long as the disability payment is not being calculated based on the injury and/or length of time off the job, it is not compensation for the injury or illness, but continuation of wages/salary hence W2.

[Guest curmudgeon]

I do not totally agree. Severance payments are also reported on a W2, but not eligible for salary deferral elections. Unless you would consider the payments for services rendered, I do not think they are eligible for purposes of deferring. However, I agree that unless your definition of compensation excludes such payments, they would count for 415 comp.

[Kirk Maldonado]

curmudgeon:

Do you have a citation to authority that supports your position?

[jaemmons]

Was the individual terminated from employment when they were receiving disability payments (leaves of absence is not a termination of employment). If not, the disability payments should be eligible for all plan purposes, unless you can find a specific provision which would exclude these payments.

[Belgarath]

He became disabled and came back to work during the same plan year (2004).

[jaemmons]

Belgarath,

Sounds like they were an employee, and since you previously stated that the plan does not exclude disability payments, the individual should have been able to receive benefits on these payments (e.g. - deferrals, match, profit sharing etc.) based on the plan's definiton of compensation (W-2).

[Guest curmudgeon]

Kirk-

There is a good discussion about it in Sal Tripodi's books, chapter 11. The cite is T reg. 1.401(k)-1(a)(3) stems from requiring "employee" status to defer.

[Kirk Maldonado]

curmudgeon:

I didn't see anything in the original post that indicated that there was a termination of employment. So I'm not following you where you say that the guy has to be an employee, because he was an employee at all times.

Please explain your point.

[Guest curmudgeon]

The payments are being made by a disability policy, and being funneled through the W2. The W2 is just the reporting mechanism, the Employer isn't paying an Employee compensation, the employee is receiving payments from a disability policy. My point was that just because it's reported on a W2, it does not automatically qualify it for eligible compensation from which deferrals may be made.

Our documents define compesation as W2 "paid by the employer" in the course of the Employers trade or business.

These payments would not qualify under this definition in my opinion.

[rcline46]

"Compensation" in all documents I have read refer to payment for services performed for the employer. No services, no "compensation". Note that it refers to "compensation" required to be reported on W-2, it does not say that which is on the W-2 is "compensation". Also note that the definition of W-2 compensation ends up referring you back to 3401, and disability pay is no where mentioned in 3401.

[jaemmons]

It appears from Belgareth's postings, that the individual was an employee during the disability period, so the compensation should have been eligible plan compensation.

Curmudgeon,

Please clarify why you feel he is was not an employee, while he was receiving disability compensation payments?

[Guest curmudgeon]

Whether you consider him an employee or not isn't the issue with this situation. That's the issue for severance pay reported on a W2. With severance pay, it is reported on a W2, but not eligible for 401(k) contributions. The intial responses to this question were such that people automatically assumed that since it's on the W2, it's eligible for salary deferrals. That simply isn't true. The issue here is whether this qualifies as compensation paid by the employer. I don't think it does. As I said in my last post, our document definition would preclude using this type of payment as compensation. It is not for services performed in the employer's trade or business, it is a disability benefit provided by insurance, funneled through a W2 for reporting purposes. Our documents do have an election to consider disability payments for people on "permanent disability" as compensation, but if that option is not elected, the do not count. I realize this situation isn't "permanent", but the payments are analagous.

With this situation, if the employer wanted to allow this person to defer nobody would ever know the difference. Under audit the IRS would see a W2 and look no further. However, if this were a situation where they didn't withhold salary deferrals when an election was present, I do not think they would be obligated to make any sort of QNEC.

[JanetM]

This is really a question of plan definition. Most of our DC plans exclude from comp any amounts received from 3rd party even if on the W-2.

In Belgarath's situation the plan defines comp as W-2. If there are not exclusions to that definition then the disabilty pay would be included for plan purposes.

Curmudgeon, does you definition mean you don't count vacation, holiday and sick pay or any other paid time off for you plan? Those are clearly not payments for services performed in employers trade or business.

[Guest curmudgeon]

Vacation, holiday, and sick pay are absolutely compensation for services performed. An employer chooses to provide these payments as part of an employee's total compensation package. If you know of an employer that provides payment for those without active employment, please sign me up! That would be every curmudgeon's dream.

What we really need to make a good determination is the complete definition of total compensation from the plan document. I doubt it is as simple as just "W2".

[E as in ERISA]

I agree with the majority here. I saw a really good article year ago in BNA portfolios or somewhere like that distinguishing between disability that is paid to the employee from a third party insurer versus disability paid by the employer. If it's paid by the employer, then I believe that it's generally treated the same as sick pay and other paid leave. Although the facts aren't 100% clear here, it sounds to me like the insurance policy may be fairly irrelevant here. That appears to be merely the employer's mechanism for funding the obligation to pay disability with the employer as the beneficiary of the policy? So the payment from the employer to the employee would be like any sick pay policy or paid leave policy where the employer pays an employee for time when no work was performed -- which generally fits within the definition of compensation as long as no termination has occurred (which is a distinguishing fact in a severance plan).

[mbozek]

C: It is not uncommon for an employer to pay comp to people who perform no services, e.g., employees who stay at home or are on paid leave. There is no requirement that the employee perform any duties in order to be paid. I have drafted termination agreements for executives who agreed to stay home for years until they reached retirement age while their pay checks were mailed or wired to them.

[g8r]

I believe those may go to whether there really is a termination of employment. I could argue that all of these payments are for services. An employer provides disability coverage as a benefit for service. The disability payments are arguably the result of this service (albeit it prior service). Severance pay is also for services -- an employer generally only pays severance b/c of prior employment.

I think the concept with severance pay is that if a person isn't a current employee, then you have an exclusive benefit problem. FYI, the IRS has been promising to issue guidance on this -- it will part of the 415 regulations.

For disability pay, I don't have a definitive answer. However, there is a safe harbor exclusion -- taxable fringe benefits, nonqualified deferred compensation, etc. can be excluded from compensation (I don't have the reg cite but it's in the 415 regs nor the specific language). I believe that payments for disability could be considered a taxable fringe benefit and excluded under that provision w/out any nondiscrimination issues. Of course that exclusion means you had concluded that it's counted for plan purposes in the first place. We know it's on the W-2 but there are some good arguments as to why it might not necessarily be counted.

And, that exclusion only helps going forward (if you amend the plan).

[ERISA1]

I know this discussion is old, and frankly, I wish I wouldn't have to re-open it. However, I've got a potential client who will hire me if I can tell her whether disability payments made under an insurance policy, that is reported on W-2, to an employee who is classified as on leave; not terminated, can be excluded from compensation. I believe this kind of income is referred to as Section 104 compensation. The current document definitely includes it; however, the question is whether one can possibly draft a plan to exclude it?

I have been reading the 415 and 414(s) regs and the ERISA Outline Book. They seem to indicate (but not clearly) that such disability income can be excluded from Compensation and still satisfy a Safe Harbor definition of compensation. The answer may revolve around whether the document defines 415 comp using the "SIMPLIFIED" definition of compensation allowed under 1.415-2(d)(10).

Does anyone agree that excluding section 104 disability income can satisfy a safe harbor under in 415 and 414(s)? (Let's assume the document will be 'individually designed'.)

If it's not a safe harbor, it is my impression that the definition will have to be tested under 414(s). This plan would not pass the test because, at present, the exclusion of 104 comp would only impact NHCEs.

I don't want to give the prospect a response that could be (relatively easily proven wrong. Would you tell them such disability can be excluded?

Thank you very much.

[TPApril]

Revisiting this discussion of TDI pay and W-2 pay and treatment or not as eligible compensation.

plan Definition of Compensation is simply W-2

Plan Sponsor used to receive TDI payments from insurance carrier and run them through payroll, so it would show up on employer W-2

Now the insurance carrier pays TDI directly and issues their own W-2.

Based on plan definition (with no embellishment beyond including 401k and 125), would TDI be included in both cases for plan compensation?