Plan sponsors can use this article to understand how compensation is defined under a Gusto 401(k) plan and how it affects contributions, matching, and compliance testing.
The definition of "compensation" for your 401(k) plan may differ from what you think of as an employee's total pay. How compensation is defined matters because it determines how employee deferrals, matching contributions, profit sharing allocations, and required nondiscrimination testing are calculated.
Under your Gusto 401(k) plan, compensation is defined as the amount your company pays an employee during the calendar year that is subject to individual income taxes, plus any pre-tax deferrals to the 401(k) plan or pre-tax elections to pay for most other benefits — like health insurance, cafeteria plan elections, and transportation spending plans. This is also known as W-2 or gross compensation and generally includes all compensation.
Note: The compensation definition in your Gusto 401(k) plan document cannot be customized.
Base pay — the annual base salary of an employee.
Bonuses, commissions, and tips — if employees get paid large, irregular bonuses, you may want to alert them of payment timing so they can plan deferrals accordingly.
Post-employment pay — compensation for work performed that is paid within the later of 2½ months or the end of the year of termination. This includes commissions, bonuses, and unused accrued sick or vacation leave, but does not include severance payments.
Pre-tax salary reduction elections — pre-tax elections to the 401(k) plan and any pre-tax employee contributions to a welfare benefit plan (like health insurance) offered under a qualified deferral arrangement. Reducing taxable wages for these elections does not reduce compensation for the 401(k) plan.
Taxable fringe benefits — examples include fitness stipends and personal use of a company vehicle reported as W-2 income.
S-corporation shareholder-employee insurance premiums — company-paid health and accident insurance premiums for S-corporation shareholder-employees with greater than 2% ownership that are reportable as wages on their W-2.
Transportation spending plan elections — pre-tax elections under Internal Revenue Code (IRC) section 132(f) are generally not subject to taxation but are included in compensation for purposes of the 401(k) plan.
Compensation earned before plan eligibility — deferrals can only come from income earned after an employee becomes eligible. Matching and non-elective Safe Harbor contributions are typically calculated based on compensation earned while a participant is in the plan. Profit sharing is generally based on full-plan-year compensation, which includes pre-entry compensation earned during the applicable year.
Compensation over $350,000 in 2025 or $360,000 in 2026 for elective deferrals only — this amount must generally be prorated for plan years less than 12 months. Even when some compensation exceeds limits, Gusto Retirement needs total compensation for each individual. Owners with self-employment income will have deductions calculated from earned income even if it is over the income limit.
Pay from other members of a legally related group — only compensation paid from the entity sponsoring the plan can be considered compensation for Gusto 401(k) plan purposes.
Contractor pay — according to the Internal Revenue Service (IRS), independent contractors cannot participate in a 401(k) plan sponsored by one of their employers. However, they can establish their own 401(k) plans. Learn about self-employed owner or partner compensation.
Severance pay — income paid as part of a severance package is not considered earned income or compensation for 401(k) purposes.
Nontaxable fringe benefits — employer-provided benefits like educational assistance (under a dollar limit) or certain employer-provided transportation benefits.
Actual expense reimbursements — reimbursement of expenses like travel or office supply purchases where the actual cost is repaid.
Compensation over $345,000 in 2025 or $360,000 in 2026 for employer contributions and nondiscrimination testing — compensation over the limit is not included. This amount must generally be prorated for plan years less than 12 months. Even when some compensation exceeds limits, Gusto Retirement needs total compensation for each individual. Owners with self-employment income will have deductions calculated from earned income even if it is over the income limit.
This information is intended to provide general information about the Gusto 401(k) plan provisions. It is not intended to be tax or legal advice. If you have specific questions about your situation, you should consult your tax advisor.