Can I exclude rewards from Compensation?

We have a 401(k) Plan that defines Compensation as Section 3401 comp, excluding:

• 414(s) Safe Harbor Exclusions
• Differential Wage Payments
• Stock-related compensation
• Nonqualified deferred compensation payments

We currently have an "award" system, where employees can receive "points" from others for recognition of job well done.  They use the points to purchase items from a catalog.  My questions are:

1) Is this included in Compensation for the 401(k), or can it be excluded as a "fringe benefit"?

2) If it is included in Compensation, can we amend the plan to exclude it?

3) If we amend the plan, can that be done mid-year?  Do we need to send out notices?  Any nondiscrimination testing issues?

calexbraska, while the Code of course has an entire section (132) dealing with qualified fringe benefits, I think the term "fringe benefit" as used in Treas. reg. 1.414(s)-1(c)(3) is not limited to Section 132 fringes, but would include an item like this that is taxable, but still a "fringe benefit." Informal IRS guidance such as publications and training materials with respect to taxable "fringe benefits" gives the term a broad and somewhat uncertain meaning. Therefore, my thought is that if you exclude them you are not busting the 1.414(s)-1(c)(3) safe harbor, if that's what you're after.

However, I am not sure that the safe harbor permits you to exclude "stock-related compensation" or differential wage payments, so you may already be required to test your compensation definition for nondiscrimination. Of course, if you have to test your definition for nondiscrimination, it seems unlikely that excluding this "points" compensation would cause you to fail.

However, since I don't see an exclusion for this "points redeemable through a catalog" taxable fringe benefit from IRC sec. 3401, I think you would need to include the exclusion in your plan document.