Editor: Annette B. Smith, CPA
The employment tax consequences related to a corporate change of control event generally depend on the type of event, namely whether there is an asset purchase, a merger, or a stock acquisition.
Secs. 3101 and 3111 impose FICA taxes on wages, as defined in Sec. 3121(a), with respect to employment, as defined in Sec. 3121(b). FICA taxes consist of the old age, survivors, and disability insurance tax (Social Security tax) and the hospital insurance tax (Medicare tax); these taxes are imposed on the employer and the employee. The term “wages” is defined in Sec. 3121(a) for FICA tax purposes as all remuneration for employment, subject to certain specific statutory exceptions.
Social Security taxes are imposed on wages up to a certain amount, referred to as the Social Security wage base or simply the wage base. Once an employee earns wages in excess of the Social Security wage base ($106,800 in 2011), wages are no longer subject to the Social Security tax. The Medicare tax is imposed on all wages paid by an employer to an employee.
Technically, Sec. 3101(a) imposes the employee’s portion of the Social Security tax on the employee. However, Sec. 3102 provides that an employer must withhold the amount from wages paid by the employer to an employee and must pay the withheld amounts over to the government.
If an employee works for more than one employer during the calendar year, the combined amount of wages subject to the employee portion of the Social Security tax is capped at the Social Security wage base. However, the Code does not contain an exception allowing an employer to reduce or eliminate withholding the Social Security tax from the employee’s wages when the employee receives wages from a second employer or multiple employers during the calendar year, even when the employee has reached the Social Security wage base taking into account wages paid by another employer or a combination of employers. Instead, Sec. 6413(c) provides for a “special refund” that allows the employee to claim a refund on the employee’s individual income tax return of the amount of excess Social Security taxes withheld from the employee’s pay because the employee had more than one employer during the calendar year.
There is no special refund mechanism for an employer that paid wages to the employee after the employee reached the Social Security wage base (see Rev. Rul. 57-32). For example, if an employee receives wages in excess of the wage base from one employer and wages from a second employer that do not equal the wage base, the employee would be entitled to a refund of Social Security tax withheld by the second employer, but neither employer would be entitled to a refund of the employer portion of the Social Security tax paid by each employer. Accordingly, the general rule is that each employer has its own wage base with respect to the employer’s portion of the Social Security tax.
The FUTA tax is an excise tax on wages paid by the employer. An employer pays a 6.2% tax on wages up to a fixed wage base of $7,000. However, the FUTA tax rate can be reduced by the amount of state unemployment insurance tax an employer pays. As with the employer’s portion of the Social Security tax, the general rule is that each employer has its own wage base with respect to the FUTA tax.
One exception to the general rule—the successor rule—applies in certain cases when the assets of an employer are purchased. For purposes of determining whether a successor employer has reached the Social Security wage base, the successor rule allows a successor employer to take credit for the wages that a predecessor employer paid to an employee during the calendar year if certain rules are met.
The Code and regulations provide a three-part test for the employer’s Social Security tax and FUTA tax. Wages paid, or considered as having been paid, by a predecessor to an employee are, for purposes of the annual wage base, treated as having been paid to an employee by a successor if:
- The successor during a calendar year acquired substantially all the property used in a trade or business, or used 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 prior to the acquisition and is employed by the successor in its trade or business immediately after the acquisition; and
- The wages were paid during the calendar year in which the acquisition occurred and prior to the acquisition.
If the three-part test is met, a successor may take credit for the wages paid by the predecessor for purposes of calculating the amount of employer FICA and FUTA taxes the successor owes. When an employee’s combined wages from the predecessor and successor reach the Social Security and the FUTA wage base limits, the successor no longer owes FICA or FUTA tax.
The IRS has issued several private letter rulings providing some flexibility to employers for meeting the three-part test. Generally, the employees and the assets must move from the predecessor to the successor at the same time. In Letter Ruling 8729027, the IRS concluded that the taxpayer met the requirement that an employee must be employed by the predecessor immediately prior to the acquisition and be employed by the successor immediately after the acquisition where the predecessor transferred employees to the successor in two steps during the year to ease the administrative workload caused by the transfer. In Letter Ruling 9027029, however, the IRS determined that a 33-day period between an acquisition and the transfer of employees did not meet the “immediate” requirement.
In Rev. Ruls. 68-105 and 72-269, the IRS determined that the requirement that the successor acquire substantially all the property used in a trade or business of the predecessor was met where the successor did not actually acquire the property of the predecessor but acquired the use of the property. In these rulings, the successor employer obtained from the predecessor employer, by means of a contract or subcontract, the use of government-owned property. The facts of these rulings were unique in that they involved acquiring the use of government property, but the IRS did not place any special significance on these particular facts in determining that acquiring the use of the asset was sufficient to meet the requirement to “acquire substantially all the property used in a trade or business of the predecessor.” See also Letter Ruling 8729027 (private employer acquired use of all the assets used in research and development, finance, engineering, marketing, public affairs, facilities, purchasing, industrial engineering, corporate development, and public relations of the predecessor).
In Letter Ruling 9006053, the property, or use of the property, being acquired was solely intangibles such as copyrights, know-how, processes, techniques, formulas, technology, and patents associated with manufacturing, marketing, and sale; physical assets, such as furniture, fixtures, office machines, and personal computers, stayed with the predecessor. The IRS ruled that this was sufficient for purposes of the successor rule. The IRS, however, has limited application of the successor rule where the entity claiming to be a successor had no legal interest in the assets. See Chief Counsel Advice 200017041 (analyzing whether an entity determined to be the statutory employer under Sec. 3401(d)(1) can be the successor with respect to the common-law employer for whom the services are performed).
The results of a merger are generally the same as an asset purchase that meets the successor rule. Rev. Rul. 62-60 provides that if a corporation absorbs another corporation in a statutory merger or consolidation, the resultant entity is regarded as the same taxpayer and same employer as the absorbed corporation for FICA and FUTA purposes. In this way, the successor entity may take credit for the wages paid by the predecessor for purposes of calculating the amount of both the employee and employer FICA tax, as well as the FUTA tax, that the successor owes.
If a company purchases the stock of another entity, the employment tax results are different than in the case of an asset purchase or a merger. Generally, the entity that is purchased becomes a subsidiary of the purchaser. Accordingly, the subsidiary remains the employer of the employees, and the employees have only one employer during the year even though another company purchased the company for which the employees work.
In some cases, these rules work in tandem. Initially, there may be a stock purchase and within the same calendar year the new subsidiary is merged into the purchaser. In this situation, Rev. Rul. 62-60 generally allows the purchaser to take credit for the wages paid by the predecessor for purposes of calculating the amount of employer FICA and FUTA tax the successor owes. Similarly, there may be situations where subsequent to a stock sale, but within the same calendar year, the purchaser acquires all the employees of the predecessor and use of all the assets of the predecessor, such that the successor rules are met and the purchaser may take credit for the wages paid by the predecessor for purposes of calculating the amount of employer FICA and FUTA taxes it owes.
Employers undergoing these types of change-of-control events may not be aware of these rules or may be administratively unable to make system changes necessary to carry over allowable wage bases and prevent the duplication of FICA and FUTA taxes. In that case, employers may seek a credit or refund of overpaid taxes under Sec. 6413(b) for the period in which the limitation period remains open.
Annette Smith is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington, DC.
For additional information about these items, contact Ms. Smith at (202) 414-1048 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with PricewaterhouseCoopers LLP.