Compensation Applied Incorrectly Costs Big Bucks

Translating the legal definition of “compensation,” as captured in the defined contribution (DC) plan document, to payroll programming is complex. When it is applied incorrectly, it leads to high costs to calculate and fund missed compensation deferrals or contributions, along with the costs to correct the error via the Internal Revenue Service Employee Plans Compliance Resolution System.

Compensation as defined in the plan documents can be applied differently to various aspects of plan administration; deferrals, employer contributions, and testing can all use different definitions of eligible compensation. And that definition of eligible compensation covers a wide variety of elements, including:

  • salary
  • hourly wages
  • tips
  • overtime
  • premiums for shift differential
  • call-in premiums
  • vacation pay
  • bonuses
  • taxable benefits
  • severance pay

In Karlson v. ConAgra Brands Inc., the plaintiff (who, prior to termination, was the senior director of global benefits and a member of its DC plan administrative committee) alleged that the plan sponsor should have considered certain post-termination bonuses as eligible compensation. The suit alleges that, according to the plan document, participants could defer from their compensation and the employer would match those deferrals, and the plan defined “compensation” to include certain post-termination payments.

The plaintiff alleged that in 2016 the plan fiduciaries altered their reading of the plan document to exclude those bonuses, and therefore failed to apply elective deferrals from these bonuses and match such deferrals. According to the complaint, the alleged failure could potentially affect several thousand participants.

In the instance of a compensation failure, if too much compensation was recognized, the plan sponsor may have to issue distributions of the excess deferrals, plus earnings and matching contributions would be forfeited. If the reverse occurred and all eligible compensation was not included (as alleged in this instance), the plan sponsor may have to make corrective contributions to make up for missed savings opportunities. When corrective contributions are required, the employer is required to fund both the missed deferral and matching components, and related earnings.

The IRS calls out compensation errors in its “Plan Fix-It Guide” here.

Bottom Line: This lawsuit calls out a common plan failure. Plan sponsors should be aware of the issue and take the opportunity to review their plan language against actual administrative practices. It is also important to review compensation when the definition in the plan document changes, when programming is altered, or following changes to the payroll vendor or software.