Includible or Excludable Income for Nonresident Aliens in 403(b) Plans


By Jason Lumpkin

In general, 403(b) plans sponsored by nonprofit organizations are subject to what is known as the “universal availability rule,” which requires that all employees of an organization be eligible to make contributions to the plan. In other words, if the opportunity to contribute to a 403(b) is given to one employee, the same opportunity must be given to all employees, with limited exceptions for some part-time employees, students, employees already covered under another plan, and/or nonresident aliens.

While these exclusions are allowable, many nonprofit organizations employ a number of nonresident aliens who, by design, are permitted to contribute a portion of their compensation to their 403(b) plan on a pre-tax basis and/or receive additional contributions from the employer (i.e. matching or nonelective contributions). For these purposes, it is important to consider the special rules and regulations that determine the specific items of compensation that (1) an employee can actually contribute to a 403(b) plan, and/or (2) the plan can recognize to allocate employer contributions, regardless of the fact that he or she may be “eligible” to participate under the terms of the plan.

Internal Revenue Code (“IRC”) Section 403(b) defines includible compensation to mean “…the amount of compensation which is received from the employer…, and which is includible in gross income…for the most recent period….” (emphasis added).

In general, gross income for nonresident aliens who perform services within the United States (U.S.) is the same as gross income for U.S. citizens. However, in some cases, an income tax treaty between the U.S. and a foreign country may allow a nonresident alien to exclude from his or her compensation those amounts earned while performing services within the U.S. As such, in order to determine whether a nonresident alien’s compensation earned within the U.S. is includible compensation for purposes of making or receiving contributions in a 403(b) plan, it is important to understand the income tax agreement between the U.S. and the foreign country.

Additionally, under IRC Section 872(a), a nonresident alien is generally not subject to U.S. income tax with respect to compensation paid for services performed outside of the U.S. Accordingly, compensation paid to a nonresident alien performing services outside of the U.S. would not be included in his or her gross income, and, therefore, would not be includible compensation for purposes of the 403(b) plan.

In summary, an organization that allows nonresident aliens to participate in their 403(b) plan program should consider these complex compensation issues to ensure that nonresident aliens who are eligible to participate in the plan do not make or receive contributions based on amounts that are not considered “includible compensation” under IRC Section 403(b).

Conversely, 401(k) plans are subject to a special rule under Regulation 1.415(c)-2(g)(5), which provides that “amounts paid to an individual as compensation for services do not fail to be treated as compensation…merely because those amounts are not includible in the individual’s gross income on account of the location of services.” In light of this Regulation, it may be beneficial for some nonprofit organizations that employ a large number of nonresident aliens to consider a 401(k) plan in addition to, or in lieu of, a 403(b) plan to avoid the complexities associated with compensation relative to 403(b) plans.

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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.

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