Employer’s Liability for FICA Taxes Can be Offset by Self-Employment Tax Paid by Workers

In a recent Chief Counsel Advice (CCA), the IRS concluded that an employer who misclassified employees as independent contractors could offset FICA taxes owed by the employer with self-employment taxes paid by the workers.

Where workers are properly classified as employees, the employer is liable for the employer portion of the FICA tax, and the employee is liable for the employee portion of the FICA taxes. The employer portion of the FICA taxes is 7.65% of the wages paid to the employee subject to certain thresholds.  The employee portion is also 7.65% of the wages paid to the employee subject to certain thresholds.

FICAThe employer is required to withhold and pay-over the employee portion of the FICA tax to the IRS, but the employee is ultimately liable for the employee portion, and the IRS can collect the employee portion of the FICA tax from either the employer or the employee.

Where workers are properly classified as independent contractors, the workers are responsible for paying self-employment tax on their self-employment income. The self-employment tax is 15.3% of the worker’s self-employment income, which is the equivalent of the combined employer and employee portions of the FICA taxes.

Under IRC section 3509, an employer who fails to deduct and withhold the employee portion of the FICA taxes from an employee’s wages without intentionally disregarding its obligations, is liable only for 20% of the amount of FICA taxes due.  But if the employer fails to file the required information returns, the liability amount is 40% of the FICA taxes due.

Failure to timely deposit FICA taxes or self-employment taxes generally gives rise to a penalty under IRC section 6656.  However, under IRC section 6521, if: (i) an amount of employee wages is erroneously treated as self-employment income; (ii) correction of the error would require assessment of FICA taxes, and refund or credit of the self-employment tax; and (iii) correction of the error is authorized as to one tax but prevented by law as to the other, then the amount of the adjustment with respect to the one tax is reduced by the amount of the adjustment prevented by law.

In the instant case discussed in the CCA, the employer treated certain workers as independent contractors. The IRS subsequently determined these workers were properly classified as employees. The IRS determined that the employer was liable for both the employer and employee portions of FICA taxes.

The employer requested that IRS grant employer the benefit of a credit under IRC section 6521 to be applied against the employee share of FICA liability since the workers had reported their compensation on their individual income tax returns and had paid self-employment tax on the reported self-employment income. The period of limitations on refund of self-employment tax was closed, but the period of limitations on assessment of FICA taxes was still open.

The IRS determined that, in this situation, employer was allowed under IRC section 6521 to offset the self-employment tax paid by its employees against their liability for the employee share of FICA taxes.   This of course eliminated the employer’s liability to pay such tax.

The IRS also concluded that the above result did not affect employer’s liability for penalties and additions to tax for failure to file information returns and withhold and pay-over FICA taxes.

Misclassification of workers independent contractors or employees can lead to significant tax consequences. If you need assistance with worker classification questions, drafting an appropriate independent contractor agreement or handling a FICA tax matter, please contact Jeff Senney or Matt Stokely at 937-223-1130 or Jsenney@pselaw.com

AUTHOR: Jeff Senney
jsenney@pselaw.com