Severance comp vs post-severance comp

[Gilmore]

A participant terminates from a 401(k) plan on 6/30/2014.

The participant is paid their final paycheck on their date of termination, 6/30/2014.

The paycheck includes their final hours of service, plus 6 months severance pay.

Assuming total gross compensation is used for plan purposes, is the 6 months severance pay included for plan purposes since it is technically not paid post-severance?

Thank you.

[ETA Consulting LLC]

Severance Comp is "NEVER" included in plan Compensation. When determining whether Compensation is Severance Comp, timing means nothing, it's Compensation paid for the employee to leave. Had he stayed, he wouldn't have received it. Plan Compensation must be compensation you worked for (or deemed to have worked for, i.e. vacation and holiday pay). Severance Comp is money paid for you leave and stop working.

Does the differentiation make sense?

Good Luck!

[KJohnson]

I am not so sure on that. First, it is not post-severance compensation as defined in the 415 regs. Of course severance paid after termination would not be included if you plan's definition of compensation mirrors the 415 post-severance mandatory exclusion.

But, since it is not post-severance then it is a question of whether it fits into your plan's normal definition of compensation. If you use a W-2 or a 3401(a) definition similar to what is pasted at the end of this email then in both you are using the 3401(a) definition of wages. If you track over to the 3401(a) regulations at 31.3401(a)-1(b)(4) you will find

(4) Dismissal payments. Any payments made by an employer to an employee on account of dismissal, that is, involuntary separation from the service of the employer, constitute wages regardless of whether the employer is legally bound by contract, statute, or otherwise to make such payments.

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1) Information required to be reported under Code §§6041, 6051 and 6052 (Wages, tips and other compensation as reported on Form W-2). Compensation means wages, within the meaning of Code §3401(a), and all other payments of compensation to an Employee by the Employer (in the course of the Employer's trade or business) for which the Employer is required to furnish the Employee a written statement under Code §§6041(d), 6051(a)(3) and 6052. Compensation must be determined without regard to any rules under Code §3401(a) that limit the remuneration included in wages based on the nature or location of the employment or the services performed (such as the exception for agricultural labor in Code §3401(a)(2)).

(2) Code §3401(a) Wages. Compensation means an Employee's wages within the meaning of Code §3401(a) for the purposes of income tax withholding at the source but determined without regard to any rules that limit the remuneration included in wages based on the nature or location of the employment or the services performed (such as the exception for agricultural labor in Code §3401(a)(2)).

[Kevin C]

What does the plan say? The definition of Compensation will provide your answer.

[Gilmore]

Compensation is defined as W-2 compensation, which includes all compensation reported on the participant's W-2.

I am assuming that all of the compensation paid to the participant on their date of severance will be included on their W-2.

To KJohnson's point, the only excluded compensation is "leave type" compensation paid post-severance, as permitted by 415.

It would seem to me that the compensation should be included since it is not paid post-severance, however I have also heard similar comments as Toolkit's, that severance comp is never included. I had always assumed, however that true severance comp was paid after severance.

Since the participant in question is an HCE, and the additional compensation will have an affect on the ADP test, I want to be certain.

Thanks.

[Kevin C]

Severance pay is not included in Section 415 Compensation. That's one of the reasons we use it as the starting point for Plan Compensation in the documents we prepare.

1.415©-2

(b)Items includible as compensation.—

For purposes of applying the limitations of section 415, except as otherwise provided in this section, the term compensation means remuneration for services of the following types—

(1)

The employee's wages, salaries, fees for professional services, and other amounts received (without regard to whether or not an amount is paid in cash) for personal services actually rendered in the course of employment with the employer maintaining the plan, to the extent that the amounts are includible in gross income (or to the extent amounts would have been received and includible in gross income but for an election under section 125(a), 132(f)(4), 402(e)(3), 402(h)(1)(B), 402(k), or 457(b)). These amounts include, but are not limited to, commissions paid to salespersons, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, bonuses, fringe benefits, and reimbursements or other expense allowances under a nonaccountable plan as described in §1.62-2©.

...

But you are not required to use 415 compensation, or even a compensation definition that complies with 414(s) when determining benefits (see 1.414(s)-1(a)(2)). So, the plan's Compensation definition determines whether or not it is included. If it isn't clear, then check to see who the document gives the authority to interpret plan provisions and let them make the decision.

[KJohnson]

I guess I wonder that if severance is never 415 comp why would they have the caveat in the regs that severance is excluded if paid after severance from employment. That part would be unnecessary if it was never included to begin with. Maybe it is to take into account that severance paid before severance from employment is included under at least some of the 415 definitions (maybe W-2 or 3401(a)) and not others?. But then again, when I have seen the charts comparing the various definitions of 415 comp I have never seen a line for severance pay before termination of employment as included in some definitions and excluded in others.

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(iv) Other post-severance payments. Any payment that is not described in paragraph (e)(3)(ii) or (iii) of this section is not considered compensation under paragraph (e)(3)(i) of this section if paid after severance from employment with the employer maintaining the plan, even if it is paid within the time period described in paragraph (e)(3)(i) of this section. Thus, compensation does not include severance pay, or parachute payments within the meaning of section 280G(b)(2), if they are paid after severance from employment with the employer maintaining the plan, and does not include post-severance payments under a nonqualified unfunded deferred compensation plan unless the payments would have been paid at that time without regard to the severance from employment.

[Gilmore]

Kevin, is that a quote from your document? not the regs, correct?

[ESOP Guy]

I guess I wonder that if severance is never 415 comp why would they have the caveat in the regs that severance is excluded if paid after severance from employment. That part would be unnecessary if it was never included to begin with. Maybe it is to take into account that severance paid before severance from employment is included under at least some of the 415 definitions (maybe W-2 or 3401(a)) and not others?. But then again, when I have seen the charts comparing the various definitions of 415 comp I have never seen a line for severance pay before termination of employment as included in some definitions and excluded in others.

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(iv) Other post-severance payments. Any payment that is not described in paragraph (e)(3)(ii) or (iii) of this section is not considered compensation under paragraph (e)(3)(i) of this section if paid after severance from employment with the employer maintaining the plan, even if it is paid within the time period described in paragraph (e)(3)(i) of this section. Thus, compensation does not include severance pay, or parachute payments within the meaning of section 280G(b)(2), if they are paid after severance from employment with the employer maintaining the plan, and does not include post-severance payments under a nonqualified unfunded deferred compensation plan unless the payments would have been paid at that time without regard to the severance from employment.

I believe you are reading those regs incorrectly.

That whole section starts with this title:

(3) Compensation paid after severance from employment—

So those rules only apply to compensation after you have left employment. Those words you highlight I believe are just reiterating that fact.

If you want to know what the rules are for before employment has ended you have to go to an earlier section which reads:

(b) Items includible as compensation. For purposes of applying the limitations of section 415, except as otherwise provided in this section, the term compensation means remuneration for services of the following types—

(1) The employee's wages, salaries, fees for professional services, and other amounts received (without regard to whether or not an amount is paid in cash) for personal services actually rendered in the course of employment with the employer maintaining the plan, to the extent that the amounts are includible in gross income (or to the extent amounts would have been received and includible in gross income but for an election under section 125(a), 132(f)(4), 402(e)(3), 402(h)(1)(B), 402(k), or 457(b)). These amounts include, but are not limited to, commissions paid to salespersons, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, bonuses, fringe benefits, and reimbursements or other expense allowances under a nonaccountable plan as described in § 1.62-2©.

Remember this is just 415 comp. You can use a different definition of compensation for allocations and testing if the plan allows and you pass the needed tests.

This is what Kevin C was getting at. If your plan uses 415 comp for allocation comp you would exclude this severance pay.

To the original question I would read the document carefully on how it defines allocation compensation. Does it mention for services rendered or not? Does it reference 415 comp or not. If not, you might have to allocate on this severance pay but can't use it for tests that require 415 compensation or you might have to test your allocation comp as it isn't safe harbor. If it is the last one I would think someone made a drafting error as you shouldn't build such traps in to your document.

It has been a long time since I have had this situation but that is how I seem to recall it. Your 415 comp might exclude this pay but in effect other types of compensation in the plan might include it. Once again I think part of the disconnect in this conversation is some people are assuming allocation comp and 415 comp are the same. I don't believe that has to be true and in fact I see no reason to believe that allocation comp can't include something not in 415 comp. It just might lead you to odd testing and allocation results but possible.

But I am doing this from memory and I am willing to be told I am flat out wrong on this one.

[Kevin C]

Kevin, is that a quote from your document? not the regs, correct?

The quote is from 1.415(c )-2(b). Our document has basically the same language that applies if you elect compensation based on the Section 415 definition.

[KJohnson]

I think the majority of plans out there use a W-2 definition or a 3041(a) definition because that is what employers seem to understand. Under that definition I think it is included.

My point on the post-severance language is that there would be no need to specifically exclude it for post-severance periods if it could never be 415 compensation to begin with.

[Gilmore]

Well I checked with our document provider who was of the opinion that severance compensation should not be included in plan compensation whether it is paid pre- or post- severance.

I also spoke with a VERY respected ERISA consultant who said if the severance pay is paid on or before severance it is to be included as plan compensation.

[QDROphile]

So what are you going to do about the difference of opinion? Are you going to go find a different document provider because the document provider proved incompentent and the document was inadequate or do you now think that the consultant is only very respected instead of VERY respected?

[Gilmore]

Well actually I spoke with the other document provider that we use (changing with restatements), and they agreed with the consultant who says the comp should be included. They are working to get me some back up from and IRS Q&A session.

Hard to say anyone is incompetent on this topic since the opinions seem pretty split and everyone seems pretty confident that their opinion is correct.

[QDROphile]

The VERY respected consultant is correct. The outcome is determined by the plan document and good arguments can be made for designing the plan to exclude severance pay without regard for timing.