Definition of Compensation to be used include or exclude disability payments?

[Bruddah Kimo]

Having an argument with a plan sponsor over the definition of compensation under their plan. Compensation is defined as Code 3401 comp including deferrals but excluding 1) comp prior to participation; 2) while an ineligible employee; and 3) amounts in Regulation §1.414(s)-1©(3) (i.e., reimbursements or other expense allowances, including fringe benefits (cash and non-cash), moving expenses, deferred compensation and welfare benefits, even if includible in gross income).

Here is the issue - throughout the year they may pay 'temporary disability payments' to employees that is 100% paid by the employer and included a taxable income on their W-2. Client claims this amount is to be excluded from plan compensation and that only payment for actual work performed should be included. I argue that since payments are made by employer and includible in W-2 taxable income it is treated no different than sick pay and is included in plan compensation.

Can these 'disability payments' be construed to be a payment under §1.414(s)-1©(3) and therefore excludable from plan compensation as the client insists?

[Bruddah Kimo]

Even though the payments to employees are made 100% by the employer, not though a plan the employer is making contributions to? Would you then be considering it a 'welfare benefit' (even though there is no plan the payments are based on) ? How would it differ from a 'sick pay' or 'vacation pay' payment to the employee?

[PensionPro]

I believe disability payments would be excluded as fringe benefits because they are irregular and/or additional under 3rd exclusion in the plan's definition.