Employee self-employment tax offsets employer FICA liability but not penalties

Plain-English summary

An employer had intentionally misclassified workers as nonemployees, making the reduced assessment rules of section 3509 unavailable. The workers reported the compensation as self-employment income and paid self-employment tax, but their refund limitation periods had closed while the employer's FICA assessment period remained open. Chief Counsel concluded that section 6521 permits the employer's liability for the employees' share of FICA to be reduced by the self-employment tax the employees erroneously paid. That offset does not relieve the employer of penalties or additions to tax, including a possible failure-to-deposit penalty, because the employer still failed to withhold and deposit FICA when required.

Ruling snapshot

• Question: May employee self-employment tax offset an employer's employee-share FICA liability when section 3509 does not apply, and does the offset reduce penalties?
• Outcome: The tax offset is allowed under section 6521, but penalties and additions to tax are unaffected.
• Key authorities: IRC §§ 3101, 3102, 3509, 6521, and 6656; Rev. Rul. 86-111

Full text (IRS public release)

ID: CCA_2018020217530746
UILC: 6521.00-00, 6521.01-00, 6521.01-
01, 6521.02-00
Number: 201808016
Release Date: 2/23/2018
From:
Sent: Friday, February 02, 2018 5:53:07 PM
To:
Cc:
Bcc:
Subject: RE: Sections 6521, 3402(d), & 3102(f)(3)

We’ve addressed your issues below. Please let us know if you have further questions.

Thanks,

                                          Issues

       (1)       Whether section 6521 allows an employer to offset self-employment

compensation erroneously paid by its employees against its liability for the employees’

share of FICA where section 3509 does not apply and section 6521 applies to the

employees.

       (2)       What is the effect of the offset on the employer’s penalties and

additions to tax?

                                          Facts

       A taxpayer treated certain workers as nonemployees. After an examination,

the Service determined that the workers are properly classified as the taxpayer’s

employees, that relief under Section 530 of the Revenue Act of 1978, Pub. L. 95-600,

92 Stat. 2885 (relieving employers from FICA in certain circumstances), is not available,

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and that the employer is liable for the employer and employee shares of FICA. Section

3509 does not apply because of evidence of intentional disregard. The employer would

like a credit under section 6521 against its employee FICA liability where the workers

reported their compensation on their individual income tax returns and paid self-

employment compensation. The period of limitations on refund of self-employment tax

is closed, but the period of limitations on assessment of employee FICA taxes is open.

                                  Conclusions

   (1)      Section 6521 allows an employer to offset self-employment

compensation erroneously paid by its employees against its liability for the employees’

share of FICA where section 3509 does not apply and section 6521 applies to the

employees.

   (2)      The applicability of section 6521 does not affect the employer’s liability

for penalties and additions to tax.

                                    Analysis

   Section 1401 imposes a tax upon each individual’s self-employment income,

which is defined generally by section 1402(b) as net earnings from self-employment.

   Section 3101 of the Code imposes Federal Insurance Contributions Act (FICA)

taxes on an employee. Section 3101(a) imposes Social Security tax, section 3101(b)(1)

imposes Medicare tax, and section 3101(b)(2) imposes Additional Medicare tax on

higher earners.[i] Section 3102(a) requires an employer to deduct and withhold from the

wages of an employee the taxes imposed on the employee by section 3101. Section

3102(b) makes the employer liable for those taxes. Although the employer is liable for

the Social Security and Medicare taxes, the employee remains ultimately liable, and the

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Service may collect the tax from either the employer or the employee. Karagozian v.

Commissioner, 106 T.C.M. (CCH) 22 (2013), aff'd, 595 F. App'x 87 (2d Cir.

2015).[ii] Section 3102(f)(3) provides that if an employer fails to deduct and withhold the

Additional Medicare tax and that tax is paid by an employee, the tax shall not be

collected from the employer, but the section does not relieve the employer from liability

for penalties for failure to deduct and withhold. There is no corollary provision for the

Social Security and Medicare taxes.

   Section 6656 generally imposes a penalty for the failure to timely deposit taxes.

   Section 6521 provides that if (1) an amount of self-employment income is

erroneously treated as wages (or vice versa), and (2) correction of the error would

require assessment of self-employment tax and refund or credit of the FICA tax

imposed by section 3101 (or vice versa), and (3) the correction of the error is authorized

as to one tax but prevented by rule of law (other than section 7122, offer-in-

compromise) as to the other tax, then the authorized amount of the adjustment with

respect to the one tax is reduced by the amount of the adjustment prevented by rule of

law that would otherwise be required with respect to the other tax. This rule applies

only where the required assessment and refund or credit are for the same taxable

year. Bronson v. Commissioner, 64 T.C.M. (CCH) 1254 (1992).

   Section 3509 generally provides, in relevant part, that an employer who fails to

deduct and withhold from wages the employee’s FICA taxes without intentionally

disregarding its obligations is limited in its liability for the employee’s FICA taxes to

twenty percent of the amount determined under section 3101 (forty percent if the

employer failed to file information returns without reasonable cause). Section

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3509(d)(1)(C) provides, in relevant part, that if any part of the employer’s liability for tax

is determined under section 3509, section 6521 shall not apply.

   Revenue Ruling 86-111 clarifies the application of section 6521:

   [I]f the amount of the employer's liability for the employee's share of FICA
   is determined under section 3509, then section 6521 cannot effect a
   reduction in that employer liability. The only tax liability determined under
   section 3509, however, is the employer's. Moreover, section
   3509(d)(1)(A) states that the employee's liability is not to be affected by
   the assessment and collection of the tax determined under section
   3509. Accordingly, application of section 3509 to the employer's tax
   liability for the employee's share of FICA does not preclude the employee
   from enjoying the benefit of section 6521, if that section is otherwise
   available.

Rev. Rul. 86-111, 1986-2 C.B. 176 (1986). Because section 3509(d)(1)(C) does not

render section 6521 inapplicable to the employee, it must be read to render section

6521 inapplicable to the employer. By inference, absent the applicability of section

3509, section 6521 could otherwise be applicable to the employer. Thus, where section

3509 does not apply and section 6521 applies, the employer’s liability for the tax

imposed by section 3101 is reduced by the amount the employees paid as self-

employment tax.

   Although no provision of law specifically addresses the impact of the employee’s

payment of Social Security and Medicare taxes required to be withheld by the employer

on penalties applicable to the employer, those penalties apply according to their

terms. Cf. § 3102(f)(3) (providing no relief to employer from liability for penalties for

failure to deduct and withhold Additional Medicare tax where employee paid tax). An

employer who fails to withhold and deposit FICA taxes has failed to do so regardless of

whether its employees pay those taxes, and the employer therefore may still be liable

for the penalty under section 6656.

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[i] Social Security and Medicare are longstanding provisions, whereas the Additional
Medicare tax was imposed by the Patient Protection and Affordable Care Act in 2010.

[ii] Karagozian addressed liability for the 2008 taxable year, and therefore did not
address the Additional Medicare tax.