(but only if the contribution would have been taxable if paid as cash compensation when the services were performed).
what it refers to is whether those contributions by your wife are now taxable, even though she was not a non resident alien at the time. So if she made those contributions with after-tax monies way back when, then you can exclude them from the lump-sum payment she recently received. But if those were pre-tax contributions way back when, then they remain part of the lump payment.
In a nutshell, you shouldn't be taxed on those contributions twice. the IRS is saying, either those contributions were from her earnings after she had paid taxes to Japan way back when but if she didn't then they are subject to tax now.
