Moving Employees Between Commonly Owned Entities and MSOs

TECHNICAL BRIEF · MSO COMPLIANCE

By Alex Jones, EA, CFP®, ChFC®, CLU®, CEPA, Co-Founder, Guardian Tax Consultants®

Intended audience. This brief is for CPA firms, tax counsel, and family offices reviewing staffing arrangements between a management services organization (“MSO”) and one or more operating companies (“OpCos”) under common ownership.

In short

When employees move from an OpCo to a commonly owned MSO, or are shared between the two, several separate federal and state rules come into play. No single rule decides the outcome; each one is tested on its own. Who the common-law employer is drives payroll reporting. The successor-employer and common-paymaster rules may limit duplicate Social Security and FUTA wage-base costs. Controlled-group and affiliated-service-group rules generally require the entities to be treated as one employer for retirement-plan testing. Any cost recharge between the entities is typically reviewed under §162 and §482. State unemployment rules add another layer. Clear agreements and consistent records are usually what hold the arrangement together.

Who is the employer?

Federal employment taxes start with the common-law employer. Under Treas. Reg. §31.3121(d)-1(c)(2), an employment relationship generally exists when the person receiving the services has the right to control both the result of the work and how it is done. Actual control is not required; the right to control is enough. The right to discharge is an important indicator.

In an MSO structure, this is usually the first question to settle. If staff are moved onto the MSO payroll but the OpCo continues to hire, direct, and dismiss them, the records and the reality may not match. Separately, §3401(d)(1) treats the person with control of the payment of wages as the employer for income-tax withholding purposes when the service recipient does not control the payment. This is one reason the paying entity and the directing entity should be identified deliberately and documented.

Shared employees and employee leasing

Two arrangements are common:

Transfer. Employees move to the MSO, which employs them and provides services to the OpCo under a written Management Services Agreement (“MSA”).
Shared or leased staff. Employees remain with one entity and part of their time is provided to the other, with a cost recharge.

Each arrangement can be workable. What matters is that the MSA, the payroll records, and the day-to-day direction of the work all point the same way. The MSO should be able to substantiate the services performed, the recipient’s benefit, and the arm’s-length charge, including where personnel are employed or directed by another controlled entity.

Common-paymaster rule — §3121(s)

When two or more related corporations employ the same individual at the same time and one of them pays that individual, §3121(s) and Treas. Reg. §31.3121(s)-1 treat the paying corporation (the “common paymaster”) as the sole employer for FICA purposes on the wages it disburses. Without the rule, each employer may owe the employer share of Social Security tax up to the full wage base. With it, the wage base generally applies once.

Key conditions under the regulation include:

Related corporations. The corporations are treated as related for a calendar quarter if they meet one of four tests at any time during that quarter. They may be members of a controlled group under §1563 with “more than 50 percent” in place of 80%. For non-stock corporations, there may be 50% board overlap. Or 50% or more of one corporation’s officers are officers of the other. Or 30% or more of one corporation’s employees are concurrently employed by the other.
Concurrent employment. The individual has an employment relationship with each corporation at the same time.
Disbursement and records. The common paymaster actually pays the wages and keeps the payroll books and records.

The common paymaster is primarily liable. The other related corporations are jointly and severally liable for their allocable shares. FUTA has a parallel rule in §3306(p). The regulation is written for corporations. A single-member LLC is generally treated as a corporation for employment-tax purposes under Treas. Reg. §301.7701-2(c)(2)(iv), but how the rule applies to partnerships and other non-corporate structures should be confirmed for the specific facts.

Successor-employer wage base — §3121(a)(1)

A full transfer of employees mid-year raises a different question. Under §3121(a)(1), an employer that acquires substantially all the property used in another employer’s trade or business, or in a separate unit of it, may count the predecessor’s wages paid earlier in the same calendar year toward the Social Security wage base. To qualify, the successor must employ the individual immediately after the acquisition. Treas. Reg. §31.3121(a)(1)-1(b) provides the detail. FUTA has a similar rule in §3306(b)(1).

Moving employees alone, without a transfer of the related business property, may not meet this test. When the test is not met, the new employer may restart the wage base for the year. Rev. Proc. 2004-53 describes the Form W-2 and Form 941 reporting options when the rule applies.

Benefit plans — §414(b), (c), (m), (n), and (o)

Retirement-plan coverage and nondiscrimination testing look past entity lines:

§414(b) and (c) treat employees of a controlled group of corporations, or of trades or businesses under common control (including partnerships), as employed by a single employer.
§414(m) treats members of an affiliated service group as one employer. Under §414(m)(5), the group generally includes an organization whose principal business is performing management functions for another organization, together with that organization. This provision bears directly on many MSOs.
§414(n) may treat a leased employee as the recipient’s employee for certain plan requirements. This generally applies after the person has performed services substantially full-time for at least one year under the recipient’s primary direction or control.
§414(o) authorizes regulations to prevent avoidance of these rules through separate organizations or leasing.

In practice, an MSO and its OpCos are typically aggregated for plan testing. Moving staff between them generally does not, by itself, change who must be covered. Plan documents, eligibility, and participating-employer status should be reviewed before and after any transfer.

Cost recharges — §162 and §482

When one entity’s employees serve another, the charge between them is typically reviewed under two standards. Under §162, the payment should be an ordinary and necessary business expense; compensation for personal services must also be reasonable and for services actually rendered. Under §482, the IRS may reallocate income among commonly controlled taxpayers to reflect an arm’s-length result. Treas. Reg. §1.482-9 sets out the methods for services, including the services cost method for certain low-margin support services. A recharge may be well supported when it is based on documented time or another reasonable benefit measure, invoiced periodically, and consistent with the MSA.

State payroll and unemployment considerations

State rules vary and often do not follow the federal approach:

Unemployment experience transfer. Under the SUTA Dumping Prevention Act of 2004 (Social Security Act §303(k)), states must provide for the transfer of unemployment experience when an employer transfers all or part of its trade or business to another employer under substantially common ownership, management, or control. Whether moving a workforce from an OpCo to an MSO is a transfer of business, and carries the OpCo’s experience rate with it, depends on state law. Federal guidance notes that moving a single employee is generally not a business transfer.
Common paymaster. Many states do not recognize the federal common-paymaster rule for state unemployment wage bases.
Registration and withholding. A new MSO may need its own state withholding and unemployment accounts in each state where employees work, plus new-hire reporting and workers’ compensation coverage.

Documentation

A file that generally supports the arrangement includes:

A written MSA signed before services begin.
Offer letters or transfer notices showing the employing entity.
Payroll registers showing which entity pays each employee.
Time records or allocation drivers that support any recharge.
Plan adoption documents for each participating employer.
State registration records, plus board or manager approvals of the transfer.

Frequently asked questions

Does moving employees to an MSO restart the Social Security wage base?

It may. If the successor-employer rule in §3121(a)(1) is not met and no common-paymaster arrangement applies, the new employer generally starts a new wage base for the year.

Can an MSO and an OpCo each have their own retirement plan?

They may, but they are typically tested as a single employer under §414(b), (c), or (m). Separate plans must generally pass coverage and nondiscrimination testing on a combined basis.

Is a common paymaster the same as employee leasing?

Generally not. A common paymaster applies when related corporations employ an individual at the same time and one of them pays. Employee leasing involves a recipient using workers employed by another organization. Different rules apply to each.

Do state unemployment rates follow employees to the MSO?

They may. State law determines whether the move is a transfer of all or part of a business and whether unemployment experience must transfer, so each state should be checked.

Moving Employees Between Commonly Owned Entities: Payroll, Benefits, and Documentation