The IRS on October 31 issued temporary and proposed regulations that extend the religious and family member FICA and FUTA tax exceptions to disregarded entities (T.D. 9554; REG-136565-09). The regulations also clarify the rule that owners of disregarded entities—except for qualified subchapter S subsidiaries (QSubs)—are responsible for backup withholding and information reporting under Sec. 3406.
Before 2009, the owner of a disregarded entity was treated as the employer for employment tax purposes. However, starting in 2009, a disregarded entity was treated as a separate entity for purposes of employment taxes and related information-reporting requirements; under this rule, the entity is treated as the employer of any individual performing services for the entity.
Family Member Exceptions
For FICA and FUTA tax purposes, certain services are explicitly excepted from the definition of employment. For FICA purposes, these exceptions include:
- Services of a child under the age of 18 performed in the employ of the child’s mother or father; and
- Services performed by an individual under the age of 21 employed by his or her father or mother or performed by an individual employed by his or her spouse or son or daughter (subject to certain conditions) for domestic service in the employer’s private home.
For FUTA purposes, the exceptions include:
- Services performed by an individual in the employ of his or her son, daughter, or spouse; and
- Services performed by a child under the age of 21 in the employ of his or her father or mother.
The treatment of disregarded entities as the employer has meant that services a family member performed for a disregarded entity wholly owned by another family member could not qualify for these FICA and FUTA exceptions. The temporary and proposed regulations fix this problem by stating that a disregarded entity will not be treated as a separate entity for purposes of these FICA and FUTA family member exceptions.
Religious Employee Exception
Sec. 3127 provides an exception from FICA tax where both the employer and employee are members of a religious faith that opposes participation in Social Security. The treatment of disregarded entities as the employer has also meant that services performed by a member of a qualifying religious sect for a disregarded entity wholly owned by another member of the qualifying religious sect could not qualify for the exception because, as a corporation, the entity cannot be considered a member of a qualifying religious sect.
The temporary and proposed regulations state that a disregarded entity will not be treated as a separate entity for purposes of applying the religious employee exception of Sec. 3127.
Backup Withholding and Information Reporting
When the change was made in 2009 to treat disregarded entities as separate entities for purposes of employment taxes and related information-reporting requirements, the regulations did not explicitly state that a disregarded entity is not responsible for backup withholding and information reporting under Sec. 3406 (the owner remains the responsible person). Therefore, the temporary and proposed regulations clarify that disregarded entities are not responsible for backup withholding and information reporting of reportable payments under Sec. 3406 (except in the case of QSubs, which are treated as separate corporations for employment tax purposes under a separate regulation (Regs. Sec. 1.1361-4(a)(7)).
The temporary regulations apply with respect to wages paid on or after November 1, 2011; however, taxpayers may apply the new rules to wages paid after January 1, 2009.