External employees (contractors) being paid W2

I have a staffing firm that has internal employees (work in the office) and around 200 external employees that work on jobs about 9 months out of the year, work over 1000 hours.  They all get W-2 wages and health insurance.  They want to start a 401k plan but want to exclude the external employees (known as contractors) and only have the  internal employees be part of the plan.  I am thinking they cannot do that since the "contractors" are getting W-2 wages and work over 1000 hours and some may work 12 months within a 12 month period.  The staffing firm says other staffing firms are able to have a 401k plan and not include their external employees (insist they are W-2 waged as well).  Am I missing something?  Wouldnt they have to be included if they worked 12 months, 1000 hours (some leave and come back within 12 months)?

They would not pass coverage testing if they exclude the so called "contractors".  There are about 20 eligible and there are only 6 internal employees.

I keep reading that contractors can be excluded - but arent most 1099 waged not W2?  How are staffing companies excluded contractors that are W2 waged?

Thanks

The TPA firm i work for has many staffing firm clients who have set up ESOPs.   I personally work on two.    They all want the benefits to just go to the corporate employees and not the people they are jobbing out to their clients.   And they can't do that and none of our clients exclude the people who work the temp jobs for the staffing firm's clients.  

I completely agree with you.  They have to include those employees or pass coverage without them which sounds impossible.  

If they want to try and set up some kind of points based allocation or other kind of allocations system that can pass discrimination testing that favors the internal employees go for it.  My guess is those 6 employees also have all of the HCEs making this very hard also. 

To answer your last question I don't know of any staffing firm that is excluded these types of people and we have a pretty good sample size at the firm I work for.  We here have at least 5-8 staffing firm clients I am thinking.    I don't know of any that are doing what you describe.  

This is not as cut and dried a question as you might think. In PEO world, there is always a question as to whether the real employer of the contractor is the staffing firm or the company the employee is being leased to. The first employer seems to be taking a stance that the only true employee of the company are the central office folks.

Your client may have gotten a legal opinion that what they are doing is OK and, indeed, the only way they can manage the situation without becoming a MEP.