How Rev Proc 2002-69 Affects Employment Taxes
Learn how an IRS safe harbor allows entities typically ignored for tax to manage their own employment tax duties, clarifying owner responsibilities.
For federal income tax purposes, certain business structures are ignored, with their financial activities reported directly by the owner. However, for federal employment tax purposes, these businesses are required to be treated as separate entities. This means they are recognized as distinct employers for handling all employment tax obligations.
Scope and Eligibility
This treatment applies to two specific types of business structures: disregarded entities and Qualified Subchapter S Subsidiaries (QSubs). A disregarded entity is a business with a single owner that is not recognized as a separate entity for income tax purposes. The most common example is a single-member limited liability company (SMLLC), where the LLC’s income and expenses are reported on the owner’s personal tax return.
A Qualified Subchapter S Subsidiary, or QSub, is a corporation that is wholly owned by an S corporation, and the parent S corporation has elected to treat the subsidiary as a QSub. For income tax purposes, the QSub’s assets, liabilities, and items of income, deduction, and credit are treated as belonging to the parent S corporation.
Treatment of Disregarded Entities
A disregarded entity with employees is responsible for withholding federal income tax, Social Security, and Medicare taxes from employee paychecks and remitting them to the IRS. To comply, the disregarded entity must obtain its own Employer Identification Number (EIN). This EIN must be used for all employment tax reporting and payments.
The entity is liable for filing quarterly employment tax returns and making federal tax deposits under its own name and EIN. While the entity is treated as separate for payroll taxes, it remains disregarded for all other federal tax purposes, with its income or loss passed through to the owner. This separation is mandatory.
Treatment of Qualified Subchapter S Subsidiaries
The treatment for Qualified Subchapter S Subsidiaries (QSubs) with employees requires the QSub to be treated as a separate entity for employment tax obligations, while it is ignored for federal income tax purposes. This involves obtaining its own Employer Identification Number (EIN) and using that number to report and pay employment taxes for its employees.
The QSub is responsible for all aspects of payroll tax administration, including withholding taxes from employee wages, making timely federal tax deposits, and filing the necessary employment tax returns under its own name. This treatment is not optional. The responsibility for employment taxes rests with the QSub, even though the parent S corporation remains the reporting entity for income tax purposes.
Employment Tax Reporting Consequences
The entity must operate as a distinct employer for all federal employment tax matters. This requires the entity to use its own name and Employer Identification Number (EIN) on all related filings. The primary form for this reporting is Form 941, the Employer’s QUARTERLY Federal Tax Return, which is used to report income taxes, Social Security tax, and Medicare tax withheld from employees’ paychecks.
In addition to quarterly filings, the entity is also responsible for annual unemployment tax reporting. This is done using Form 940, the Employer’s Annual Federal Unemployment (FUTA) Tax Return. The entity must calculate and pay its FUTA tax liability under its own EIN. All federal tax deposits related to these employment taxes must also be made by the entity, using its unique identifier, through the Electronic Federal Tax Payment System (EFTPS).
The entity assumes the responsibility of providing annual wage and tax statements to its employees. The disregarded entity or QSub must prepare and furnish Form W-2, Wage and Tax Statement, to each employee by the January 31 deadline. The W-2s must report the entity’s name and EIN as the employer, not the information of the owner or parent corporation. A copy of these W-2s, along with Form W-3, Transmittal of Wage and Tax Statements, must also be filed with the Social Security Administration.