How to exclude nonresident aliens from ADP testing even though they ar

[Guest Do]

Can anyone give me authority for excluding nonresident aliens with no US earned income from ADP testing. I see that they are excluded from the definition of HCE under 414(q)(8), but I think that just implies that they are not considered employees for purposes of identifying HCEs and, therefore, there is no such thing as a nonresident alien HCE. In turn, that implies that a company’s nonresident aliens are NHCEs because an NHCE is an employee who is not an HCE. The ADR for all the nonresident aliens is zero and brings down the ADP for NHCEs.

I see two possible arguments if there is no cite directly on point. First, I am thinking 401(a)(4) is authority. 401(a)(4) excludes nonresident aliens from consideration when determining whether a plan is nondiscriminatory. Since satisfaction of the ADP test is deemed satisfaction of 401(a)(4), then nonresident aliens are excluded from ADP testing.

Second, under regulation section 1.401(k)-1(g)(4), the definition of eligible employee is an employee who is directly or indirectly eligible to make a CODA. The plan I am reviewing does not exclude nonresident aliens from eligible employees; therefore, nonresident aliens appear to be eligible. However, they don’t have W-2 compensation and therefore have zero compensation under the terms of the plan. It seems that they are not directly or indirectly eligible to make a CODA.

Can anyone help with authority in the regs, an IRS ruling or notice, improve my reasoning (well, that shouldn't be too tough).

[Guest Dook]

Is the exclusion of nonresident aliens (NRAs) similar to the exclusion of independent contractors (ICs)?

If one "employed" ICs one would not include them in ADP testing whether or not the plan specifically excludes them. Right? The reason we see this exclusion more and more is as a result of the Microsoft case. But if you truly are an IC then you by definition cannot participate in the plan.

If you truly are a NRA, then you are again, by definition, not able to participate in the plan. Reg. Sec. 871 places proof of residency requirements squarely on the individuals shoulders. In lieu of clear intent to obtain residency, the employer must assume NRA status. Therefore, U.S. income is not paid and income is not subject to U.S. taxes.

I'm wondering if the HCE definition exclusion comes about for top 20% purposes maybe??

I am alos interested in any additional information anyone has on NRAs.

[Guest Do]

Thanks Dook for your thoughts. I’ll to respond as I read your post.

I don’t think the exclusion of NRAs is the same as IC. NRAs are employees who are excludable for 410(B) purposes. ICs are not employees. ICs are excluded from ADP testing because they are excluded from the universe of employees. The employees I need to keep out of ADP testing truly are NRA employees; they are employees of the employer and they have no US earned income. I wonder where you find support for your statement that “by definition” NRAs cannot participate in a plan. NRAs can be employees, an employer can make all employees eligible; therefore, NRAs are eligible employees. Furthermore, as a result of Microsoft, the ICs who are excluded are individuals the company categorizes as ICs but the IRS or the court deems to be common law employees. Moreover, Code Section 871 pertains to the 30% tax rate applicable to nonresident aliens who receive particular sources of income within the U.S. Code Section 871 excludes annuities from qualified plans as gross income subject to the 30% tax rate. Therefore, Code Section 871 assumes an NRA may participate in a plan. The HCE exclusion applies to all of 414(q), including the top 20%.

[Guest RLewis]

Seems to me that even though all your employees may eligible to participate in the plan, the NRAs, by virtue of having no W2 income, are not "eligible employees" within the meaning of 1.401(k)-1(g)(4) because (apparently) your plan requires that they have W2 income in order to make deferrals. No W2 income = can't make deferrals = not "eligible employees".

Our plan makes all employees eligible for participation and provides for both deferrals and post tax contributions. However, the plan specifically provides that NRAs with no US source income may not make deferrals. They may make post tax contributions and we incude the NRAs in the ACP test.

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RAL

[Guest Do]

Thanks RAL. It would appear that you are concurring with my second argument above; however, it is still an interpretation of that regulation based on my facts. The opposite conclusion is still plausible. Also, from what you said about your plan, the NRAs are eligible from after tax participation because the plan doesn’t say they aren’t eligible. I think the safe route is to amend the plan to exclude NRAs effective 1999 and enter Walk-in CAP for the prior years. The Walk-in CAP would be reform the plan document to be consistent with the way the plan operated. Without this reformation CAP, the plan fails ADP because the NRAs are NHCEs. Clearly, if the NRAs are not NHCEs with zero ADRs, there wouldn’t be a problem. Thanks, Do.