ESOPs, like other qualified retirement plans, will define compensation in the plan document for purposes of allocating contributions, determining deduction limits, and nondiscrimination testing. Depending on your plan design, you may have multiple definitions of compensation for different plan purposes.
Qualified plans need to define compensation for IRC Section 415 compliance testing. This definition is also used in identifying highly compensated employees (HCEs), key employees, calculating minimum benefits to non-key employees under top heavy plans, and determining deduction limits for Defined Contribution plans. There are four possible definitions, as defined in Treas. Reg. §1.415(c)-2:
Section 3401(a) wages
You must follow the plan document’s compensation definition in the operation of the plan for allocating contributions, determining HCE and key employees, performing compliance testing, and computing deduction limits. Perform annual reviews of compensation definitions and ensure that the person in charge of determining compensation is properly trained to understand the plan document.