In the working world, Social Security taxes and coverage are facts of life. Chances are, a retiring employee would be shocked when going up to the application window and hearing “Sorry, your employer did not cover you.”
In the state and local government (SLG) world, not all employers are required to pay Social Security taxes for their employees. If a governmental employer incorrectly assumed it was exempt from Social Security tax payments but received a bill for several years of back taxes, it also would be shocked.
How do we avoid those surprises? Read on.
It is true that not all SLGs are required to pay their share of FICA taxes and deduct and transmit the employee share of taxes. However, each SLG employer must know the ground rules for paying or avoiding those taxes, and then carefully apply those rules to each employee. Failure to do so can result in serious surprises for the employer and/or the employee.
SLGs and their employees were excluded from Social Security coverage when it was adopted in 1935. In 1951, SLG employers were permitted to voluntarily join Social Security and provide that coverage for their employees. This election was made by entering into a special agreement known as an “218 agreement” (named after the Social Security Act section that describes the employer obligations) between the SLG and the Social Security Administration. Things changed again in 1991 when Social Security coverage became mandatory for SLG employers/employees. But there is a catch. The coverage is mandatory only for those SLGs that do not provide an employer-sponsored retirement plan meeting certain coverage/benefit minimums and other characteristics (an “SS alternative plan”). An SLG providing a Social Security alternative plan is excluded from Social Security coverage unless it enters into a 218 agreement.
SLGs are compliant with Social Security coverage rules only if they satisfy one of three approaches:
- Case 1: An SLG is automatically subject to Social Security coverage if it does not provide an SS alternative plan.
- Case 2: An SLG is automatically excluded from Social Security coverage if it provides an SS alternative plan that meets the minimum benefit requirements.
- Case 3: An SLG that provides an SS alternative plan may provide Social Security coverage for its employees if the employees approve participation in a formal referendum (vote) and the employer memorializes that result by entering into a 218 agreement with the Social Security Administration.
So what could possibly go wrong?
Let us start out with Case 1. Assume that when the SLG board and/or officers studied the changes in 1991, they correctly concluded that they offered no employer-sponsored social security alternative retirement plan. Therefore, all of their employees were required to be covered by Social Security. That is a very simple response. However, after several years and some turnover in the management ranks, a well-meaning new board of trustees or commissioners may have decided that their employees needed an enhancement to their retirement benefits and added a retirement plan that unintentionally met the SS alternative plan minimums but without the employee referendum and 218 agreement formalities. If that occurred, then all taxes paid and all benefits earned are in error. Absent some correction, no benefits are earned for that era and the FICA taxes paid are wasted. The same result could occur if an insufficient plan is enhanced at a later date without the referendum and 218 agreement. There are probably several SLGs that provide generous employer-sponsored retirement plans and pay Social Security taxes, but never went through the formality of a referendum and a 218 agreement.
Case 2 is also prone to error. If an SLG correctly determined in 1991 or later that the employer-provided plan disqualified it from Social Security coverage, then everything is fine. Now assume that later, after some Board and/or management turnover and in a time of severe budget distress, the SLG determines that it should reduce or eliminate the employer-provided plan without immediately starting Social Security tax payments. This causes a different problem to occur. The employees find themselves eligible for unanticipated benefits (and retroactive taxes) and the employer finds itself responsible for unanticipated expenses in the form of retroactive Social Security taxes. Another problem occurs if the employer-sponsored plan imposes conditions on participating, such as a waiting period or a full-time service requirement or an exclusion for temporary employees. Unless the SLG staff is particularly alert, the SLG might not pay taxes and deduct the employees’ share for those employees or those periods when employer-sponsored coverage satisfying the SS alternative plan requirements was not available.
A Case 3 SLG may have a Social Security Plan and a proper 218 agreement. However, they could confuse the classification of employees covered by the 218 agreement or certain employees may not meet the eligibility requirements for the employer-sponsored plan.
May an employer pick and choose which employees are covered by Social Security and which are not? Or may employees self-select whether to be covered by Social Security or not? Generally, variations among employees are prohibited. Elected representatives and office holders are not automatically exempt from these rules. There are two loopholes to consider. The first is with Case 3 when designing the application of the referendum. The Social Security coverage group need not include all employees. Different groups can get different results. But no gerrymandering or favoritism is permitted. The groups selected must each share similar, broad characteristics, e.g., union vs non-union. In Case 2, the employer-sponsored plan that disqualifies participants from Social Security coverage may permit employees to waive participation in the employer-sponsored plan, thereby throwing themselves into the briar patch (Social Security coverage). Both of these options require great care in implementation and operation.
This is just a “high-level” review. There are many exceptions and technical rules, but this should give you a start on your analysis.
Your next step is to analyze the circumstances at your organization. Which employees are covered by Social Security? Are they either covered by a 218 agreement or not covered by an SS Alternative Plan? Which employees are not covered by Social Security? Are they covered by a Social Security Alternative Plan and also subject to a Section 218 Agreement? Can you find a copy of the 218 agreement?
If you would like assistance with evaluation of workforce compliance with or exemption from Social Security coverage, contact another member of the Mika Meyers Local Government Practice Group. We can assist you with understanding and applying these rules to your workforce. If errors occurred, we can help you apply the proper corrections as well as any appropriate limitations on the corrections. We can also help you identify the consequences of any proposed changes to your retirement plan on Social Security compliance.