These days, businesses are constantly reorganizing, merging, splitting up, and combining forces. As a result, an employee may change employers during the course of a year even though the employee’s job hasn’t changed. As a general rule, when an employee works for more than one employer during a year, each employer is separately liable for Social Security taxes on the employee’s wages. However, a new IRS ruling spotlights a Social Security tax-saver when one employer acquires another employer’s business operations and its employees.
When an employee works for a single employer during the year, Social Security tax is payable by both the employee and the employer only up to the Social Security wage base. For example, if an employee earns $150,000 from the employer, Social Security tax is payable only on the first $118,500 of wages for 2016. Thus, the employer and the employee will each pay a maximum tax of $7,347 for the year.
On the other hand, if the employee works for more than one employer during the year, each employer must pay and withhold Social Security tax on wages up to the Social Security wage base for the year. So, for example, if an employee earns $75,000 from each of two separate employers in 2016, each employer must pay $4,650 in Social Security tax (6.2% 3 $75,000) and withhold that same amount from the employee’s wages. The employee does get a break here: The employee can claim a credit on his or her income tax return for the excess tax withheld on wages above the Social Security wage base. Thus, in our example, the employee can claim a credit of $1,953 ($9,300 tax withheld – $7,347 maximum tax for 2016).
No break for the employers
The employers don’t get the same break, however. Each employer must pay the full tax due on wages paid to the employee, even though the combined total wages exceed the Social Security wage base. Moreover, that’s generally true even if the corporations are related. For example, if an employee is transferred from a parent corporation to a subsidiary corporation during the year, both corporations must pay tax on wages they pay to the employee up to the Social Security wage base. (But see “Common Paymaster Saves Taxes for Related Companies” below for a special rule that can cut Social Security taxes.)
KEY EXCEPTION. A special predecessor-successor rule provides an exception to the general rule that a new wage base applies in the case of a second employer. If the second employer qualifies as a successor employer, wages paid by the predecessor are counted in determining the successor’s Social Security tax obligation. Thus, in our example, if the second employer qualifies as a successor employer, the $75,000 in wages paid by the first employer will be treated as paid by the second employer. Therefore, the second employer will be required to pay the employer share of Social Security tax on an additional $43,500 of wages for 2016 ($118,500 wage base – $75,000 paid by the first employer). This cuts the tax payable by the second employer to $2,697 ($43,500 3 6.2%) and caps the amount paid by the two employers at the maximum tax of $7,347 for 2016.
The tax law provides that the predecessor-successor rule applies when an employer (the successor) “acquires substantially all the property used in a trade or business of another employer (hereinafter referred to as a predecessor), or used in a separate unit of a trade or business of a predecessor, and immediately after the acquisition employs in his trade or business an individual who immediately prior to the acquisition was employed in the trade or business of such predecessor. …” [I.R.C. §3121(a)(1)].
The regulations provide that three key tests must be met for wages paid by a predecessor to an employer to be treated as paid by the successor when applying the Social Security wage base.
• During a calendar year, the successor acquired substantially all of the property used in a trade or business, or in a separate unit of a trade or business, of the predecessor.
• The employee was employed in the trade or business of the predecessor immediately before the acquisition and immediately after the acquisition.
• The wages were paid during the calendar year in which the acquisition occurred and prior to the acquisition [Treas. Reg. § 31.3121(a)(1)-1(b)(2)].
The regulations also make it clear that the method of acquisition by the second employer is irrelevant. Moreover, the acquired property may consist of substantially all of the property used in the predecessor’s entire business or substantially all of the property used in an entity that forms part of a business. For example, the regulations provide that where a corporation that operates a chain of grocery stores transfers one store to another company, the acquisition will be treated as the acquisition of a separate unit of the corporation’s business to which the predecessor-successor rule can apply.
A successor can receive credit for wages paid to an employee by a predecessor only if the employee was employed by the predecessor immediately before the acquisition and by the successor immediately after the acquisition. However, the employee does not necessarily have to be employed by the successor in the same trade or business in which the acquired property is used. Moreover, if the acquisition involves only a separate unit of the predecessor, the employee need not have been employed by the predecessor in that particular unit so long as he or she was employed in the predecessor’s trade or business that included the acquired unit.
Parent Corporation employs U.S. employees through its U.S. subsidiaries. Some of the employees are “business employees” who perform revenue-generating business activities. Other employees are “support employees” who perform activities in support of the business activities of Parent and its subs.
Two of Parent’s subsidiaries, Corporation L and Corporation O, employed both business and support employees. Both corporations owned operating assets used by both business and support employees, including computer equipment, telecommunications equipment, software, furniture, fixtures, and contracts.
To satisfy certain regulatory requirements, Parent reorganized its operations in mid-year by having Corporations L and O transfer all of their support employees to Corporation Y. On the same date, the two subs also transferred substantially all operating assets related to the transferred support employees to Corporation Y. Corporation Y also took over leasing, contractual, and other arrangements with regard to assets used by the support employees.
Immediately after those transaction, the transferred support employees continued to perform their support functions in the same capacity and manner as prior to the transfer and had the use of the all the same assets as before the transfer.
The IRS ruled that the predecessor-successor rule applied for purposes of determining the Social Security taxes payable by Corporation Y with respect to the transferred support employees. The reorganization met all three tests in the regulations.
• Corporation Y acquired substantially all the assets of essential operations of Corporations L and O. Moreover, Corporation Y acquired all the operating assets and succeeded to all leasing, contractual, and other arrangements related to those operation.
• The support employees were common law employees of Corporations L and O before the reorganization and were common law employees of Corporation Y after the reorganization.
• Wages were paid to the employees by Corporations L and O and by Corporation Y during the calendar year of the acquisition.
Because Corporation Y qualifies as a successor employer to Corporations L and O, wages paid to the transferred employees by Corporations L and O will be treated as paid by Corporation Y for Social Security tax purposes. (IRS Ltr. Rul. 201611007, March 11, 2016.)
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