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Avoiding double taxation - an employment tax savings opportunity.

Controlling employment tax costs is a major concern in today's corporate environment. Mergers, acquisitions and other changes can cause employment tax costs to increase dramatically for the entities involved. When an entity change occurs during a calendar year, companies may severely overpay taxes under FICA, FUTA and state unemployment insurance tax acts (SUTA). Employment tax overpayments often occur when employers unnecessarily restart employee wage bases at zero subsequent to a merger, reorganization or acquisition, effectively resulting in double taxation. Most employers do not realize the extent to which employment taxes are within their control; by proactively seeking ways to control and reduce these costs, companies may reduce their tax burden and significantly increase their bottom line.

The term "wage base" generally refers to the annual level of wages subject to a specific type of taxation. For example, in 1998, the Social Security portion of FICA tax applies only to the first $68,400 of wages paid to each employee; FUTA taxation is limited to the first $7,000 of wages and SUTA wage limits are determined each year by each state. When "double taxation" of wages for Social Security purposes occurs, an individual may recoup the excess tax on his personal income tax return; however, employers typically do not have this option.

Provisions generally exist within the regulations that govern the application of employment taxes that allow employers to use the wages paid by a previous employer to meet the applicable wage bases for employees transferred as a result of a merger, reorganization or acquisition. In most instances, to use these prior wages, it is necessary for the surviving entity to be regarded as a "successor" employer. The definition of "successor" varies according to the type of tax, but is generally based on the amount of assets, property used in the trade or business that was acquired or some percentage of employees transferred as a result of the transaction. The acquired employer (which may or may not continue to exist after the transaction) is referred to as the "predecessor" employer. The transfer of the taxable wage base of each employee prevents double taxation, as the successor corporation is effectively credited for the taxable wages reported by the predecessor.

When determining if an employer qualifies as a successor, the manner in which the predecessor was acquired typically is immaterial. Qualifying transactions may include a purchase, an incorporation of a previously unincorporated entity or some modification to a previously existing partnership. Although a statutory merger or consolidation is not considered a predecessor-successor relationship for employment tax purposes, a similar result is realized, because the two parties involved are generally considered the same employer.

FICA Taxes

Once succession has been established, the successor may use the Social Security taxable wages that the predecessor employer accumulated. To the extent each employee has reached the 1998 $68,400 wage base limit prior to the transaction, no additional FICA tax liability exists on postacquisition wages. If, however, the wage base limit has not been reached, a successor employer is liable for Social Security taxes only on those wages that, when added to those wages paid by the predecessor, would comprise a single wage base limit. Successors may take credit for predecessor Social Security wage payments after establishing that a predecessor-successor relationship exists between the parties and that these Social Security wages were paid during the calendar year in which the acquisition occurred.

Example 1: A predecessor employer P paid employee E $50,000 in Social Security taxable wages prior to a mid-year acquisition. Therefore, successor employer S would be liable for Social Security taxes only on the remaining $18,400 ($68,400 - $50,000) for the calendar year in which the acquisition occurred. The employment tax savings that may be realized by S on E would be $3,100 (6.2% X $50,000).

The possibility for substantial savings arises, particularly in transactions involving significant transfers of highly compensated employees from predecessors to successors.

FUTA Taxes

FUTA tax treatment is similar to Social Security tax treatment. To the extent each employee has reached the 1998 wage base of $7,000 prior to an acquisition, no additional FUTA tax liability exists on postacquisition wages. If, however, the wage base limits were not reached, a successor is liable for FUTA taxes only on those additional wages paid that reach the wage base limit, including wages paid by a predecessor. (Of course, any employees hired after the transaction start at zero for FUTA tax purposes.) Unlike Social Security taxes, employers often duplicate the FUTA wage base when they transfer individuals between operating divisions of the same corporation. What ninny employers do not realize is that, when employees are paid and reported under the same Federal employer identification number (FEIN) throughout the year, a lateral or geographic move within a corporate structure is of no consequence; their FUTA wage base moves with them.

There is, however, one situation in which the FUTA application differs from FICA. If a predecessor did not qualify as an employer under FUTA provisions prior to a transaction, a successor cannot take credit for taxes paid by the predecessor prior to the acquisition (because no taxes were paid). Assuming it has been subject to FUTA, the successor may claim a special credit in this situation equal to the tax that would have been paid by the predecessor if it had been subject to FUTA. The special credit is limited to the tax that would have been remitted based on wages paid only to the employees actually transferred from the predecessor.

Example 2: The facts are the same as in Example 1. P had not been qualified under FUTA in the year of acquisition, but had paid $1,000 in FUTA tax during that same year. S, in acquiring 50% of P's employees, may be entitled to a $500 FUTA credit.

State Unemployment Taxes

There is considerable variation among the state unemployment insurance laws concerning "successor-in-interest" provisions. Most states recognize employers that have acquired an identifiable portion of the assets or employees, or both, of another business entity as successors.

In 1998, state wage bases vary from $7,000 to $26,400, with an average of approximately $8,500. State unemployment taxes are paid based on the rate assigned by the state and wages paid during a calendar year to each individual, up to the state's wage base limit.

The ability to transfer state unemployment wage bases is often determined by whether the predecessor's "unemployment tax experience" is transferred to the successor. The term "experience" refers to the taxes paid by the predecessor and the unemployment claims charged to the predecessor over the past several years. This experience is used to calculate the state unemployment tax rate in each state, and may be used, in some cases, to determine the tax rate issued to the successor. Transfers of experience may be beneficial or detrimental to successors, depending on the predecessor's experience. In many instances, the transfer of experience may be at the discretion of the successor, depending on the state and the nature of the transaction; many states do not allow a successor to carry over the wage bases unless there is a transfer of the predecessor's unemployment tax experience.

Another area often overlooked by employers with employees working in multiple states is the opportunity to transfer wage bases across state lines. State unemployment taxes are basically designed to collect enough revenue to cover the unemployment claim of each employee terminated through no fault of his own. If an employee performs services and is reported under the same FEIN during the year, unemployment taxes do not necessarily need to be paid to the full extent of each wage base in every state in which the individual performs services. Tracking wages and monitoring jurisdictions in which an employee performs services requires diligence. Many employers do not wish to take on this challenge and, as a result, increase their tax burden.

Many employers are unaware of reciprocal agreements and wage carry-forward provisions in Federal and state statutes. As a result, they pay far more in employment taxes than may be required. Through careful analysis and proper planning, tax-saving strategies may be implemented that may provide a tremendous benefit to employers.

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Article Details
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Author:Broomhead, Nick D.
Publication:The Tax Adviser
Geographic Code:1USA
Date:Nov 1, 1998
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