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Employment Tax Consequences of a Corporate Change of Control Event

Why it is important for tax practitioners to advise employers who may be unaware of these rules or unable to make system changes necessary to carry over allowable wage bases.

July 2011
by Kathleen Mort and Dan Boeskin/The Tax Adviser

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.

FICA Tax

Secs. 3101 and 3111 impose Federal Insurance Contributions Act (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.

FUTA Tax

The Federal Unemployment Tax Act (FUTA) tax is an excise tax on wages paid by the employer. An employer pays a 6.2-percent 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.

Asset Purchase

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.

This article has been excerpted from The Tax Adviser. View the full article here.

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