Question 285: If you have a controlled group situation with only the owner in both organizations, must the compensation from each entity be used for plan purposes? Or, because there are no NHCEs, can one of the entities establish a plan and not include the compensation from the other entity?
Answer: The answer depends on how you are using term "compensation." Let me explain, with references to the 4th edition of my book, Who's the Employer?. (Subscribers can click to view online the text of these references.)
"Compensation" is one of the most fundamental definitions of a plan. It affects 415, determination of HCE status, deductions of employer contributions, top heavy testing and minimums, amounts a participant can defer, limitations on matching contributions, allocations of employer contributions, nondiscrimination testing, and more. It is quite possible that a plan will contain multiple definitions of compensation for different purposes. I added a chapter to the 4th edition of my book just to address this key topic in its many facets.
The core definition of compensation is the 415 definition. [Q 20:1.] This definition determines compliance with the 415 limits, determination of HCE status, top-heavy, use of the 5% minimum gateway for a cross-tested plan, and more. [Q 20:11.] For this purpose, compensation includes all compensation from all controlled group members. The plan cannot alter this definition. [Q 20:8.]
For example, suppose Big Corp. has offices in San Diego and Bangor. Big Corp. sets up a pension plan covering only the employees in the Bangor office. Walter works at both offices and participates in the plan. Walter’s 2005 compensation from the San Diego office is $70,000, while his Bangor compensation is $70,000. Walter’s 415 compensation is $140,000. Walter is an HCE due to his compensation. [Q 23:8.]
The plan can modify the definition of compensation used to test for nondiscrimination. Presumably, it can limit compensation to amounts the sponsor itself pays. [Q 20:22.] But this is not a "safe harbor" definition of compensation, so the definition must pass the compensation ratio test. [Q 20:21.] If the only persons adversely affected by the definition are HCEs, then the definition surely will satisfy the test.
The plan can use any definition of compensation it wishes for the purpose of allocating contributions, if that definition complies with 401(a)(17). [Q 20:29.] Most plans prefer to use the same definition for allocations that it is used for nondiscrimination testing, which means the plan would want to use a nondiscriminatory definition.