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Who's the Employer?

Answers are provided by S. Derrin Watson, JD, APM

Exclusion of Nonresident Aliens

(Posted May 24, 2001)

Question 103: In a previous question you discussed the employment status of illegal aliens, and you mentioned the potential to exclude nonresident aliens. Would you elaborate? I thought illegal aliens could be excluded under that clause.

Answer: IRC 410(b)(3)(C) allows a plan to exclude from coverage testing:

* * * employees who are nonresident aliens and who receive no earned income (within the meaning of section 911(d)(2)) from the employer which constitutes income from sources within the United States (within the meaning of section 861(a)(3)).

To qualify under this section, a person must be a nonresident alien. That is to say:

He or she must not be a U.S. citizen
He or she must not be a resident of the U.S.

Residency is defined in IRC 7701(b)(1) as follows:

(A) Resident alien. An alien individual shall be treated as a resident of the United States with respect to any calendar year if (and only if) such individual meets the requirements of clause (i), (ii), or (iii):

(i) Lawfully admitted for permanent residence. Such individual is a lawful permanent resident of the United States at any time during such calendar year.

(ii) Substantial presence test. Such individual meets the substantial presence test of paragraph (3).

(iii) First year election. Such individual makes the election provided in paragraph (4).
(B) Nonresident alien. An individual is a nonresident alien if such individual is neither a citizen of the United States nor a resident of the United States (within the meaning of subparagraph (A).

Point (i) is significant. If you have a green card, it is my understanding that point (i) is satisfied and hence you are a resident. The substantial presence test of point (ii) requires presence in the U.S. for a minimum of 183 days, under a system described in IRC 7701(b)(3). I discuss it and give examples at Q&A 104. The first year election of point (iii) allows some aliens to advance their resident status by one year.

In terms of dealing with persons in America illegally, they are considered residents any year in which they spend at least 183 days in the U.S. They may be residents under the substantial presence test even if they haven't spent 183 days in the country during the year in question. That being the case, if a plan uses a standard year of service requirement, the odds are excellent that the workers will be treated as residents by the time that year is over.

Being a nonresident alien isn't enough, however, to permit exclusion. The worker must also have no U.S.-source earned income from the employer. That term is defined in the section 410(b) regulations and in IRC 861(a)(3). Basically, if you are being paid for working in the U.S., then you have U.S.-source income unless:

You are a crewman of a foreign vessel,
The income is not taxed in the U.S. because of a tax treaty with your home country, or
You are in the country less than 90 days during the year, the compensation is less than $3,000, and you are working for either a foreign company or a domestic company with a foreign office, and you work in the foreign office.

So, absent some unusual circumstances, even if an illegal alien avoids being treated as a resident because of the substantial presence test, he or she will nonetheless likely have U.S.-source income unless there is a tax treaty exclusion applicable to him or her.

Let's move from illegal aliens and consider folks with green cards. Consider the foreign parent of the U.S. subsidiary which are deemed to be a single employer. Many companies would like, for the sake of simplicity, to exclude everyone on the parent’s payroll, by virtue of the nonresident alien exclusion.

However, suppose a manager on the payroll of the parent comes to the U.S. to oversee the sub. He would almost undoubtedly have a green card and hence be a nonexcludable resident. I've had a lot of folks ask if it made a difference whether the parent or the sub paid the manager. IRC 861 doesn't care whether the payments are in yen or dollars, or where the check is written. It matters where the work is done. If the work is done in the U.S., it is generally U.S.-source income.

Of course, any U.S. citizens working for the parent cannot be excluded under this provision, regardless of where they are working. So, in counting employees for purposes of section 410(b), you essentially end up counting:

Everyone working in the U.S. for the parent or the subsidiary,
All U.S. citizens working for the parent or the subsidiary, and
All U.S. resident aliens working for the parent or the subsidiary.

The problems of dealing with foreign corporations and their subsidiaries are discussed in more detail in Chapter 9 of my book, Who's the Employer?.

Important notice:

Answers are provided as general guidance on the subjects covered in the question and are not provided as legal advice to the questioner or to readers. Any legal issues should be reviewed by your legal counsel to apply the law to the particular facts of this and similar situations.

The law in this area changes frequently. Answers are believed to be correct as of the posting dates shown. The completeness or accuracy of a particular answer may be affected by changes in the law (statutes, regulations, rulings, court decisions, etc.) that occur after the date on which a particular Q&A is posted.