Complicated question on 401k Compensation and Stock Compensation

[MD-Benefits Guy]

Working with a 401k plan that had mistakenly defined 401k compensation as W-2 wages with no exclusions. This of course, resulted in several defects - not enough was withheld from employee earnings because of the improper definition of compensation.  (Payroll team was only withholding from regular wages, OT and bonuses). The plan was amended effective 12/1/25 to exclude several earnings types, including equity income, from compensation.   Additionally, the payroll team would not regularly record W-2 stock transactions as they happened throughout the year.  Many were held until the last payroll and reported in December, even though the transaction occurred in July/August.

As I am going through the process of self-correction, I am left with a couple of questions on how to handle some transactions

1)  If an active employee exercised stock in July of 2025, but it was not reported in payroll until December of 2025 (when the plan was amended to exclude stock comp), would that stock transaction be considered compensation for the 401k plan?  The option was exercised when it would have been considered compensation, but not reported in payroll until later when the transaction would be excluded?

2)  For a terminated employee, similar question.  I believe if payment is made within 2.5 months of termination or by end of year (whichever is later), then the payment is to be considered compensation.  However, do I use the exercise date or the date in which the payment was made in payroll?

Thanks for any help I can get on this one.

 

 

 

 

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