The Court of Appeals for the Federal Circuit upheld a lower court decision that the wage caps for the Federal Insurance Contributions Act (FICA) and Federal Unemployment Tax Act (FUTA) must be calculated by reference to common law employment relationships rather than statutory employment relationships. Thus, a payroll service company with statutory employees who worked for multiple common law employers had to apply the FICA and FUTA wage caps to the wages paid to each statutory employee by each common law employer. The court also upheld the lower court’s decision barring the taxpayer’s attempt to reclassify some of its employees as independent contractors.

Statutory employers, such as payroll service companies, are required to remit employer FICA and FUTA taxes and employee FICA taxes even though they are not common law employers. Although FICA and FUTA taxes are capped at different wage levels, both are imposed on every employer and are based on remuneration with respect to employment paid to an individual by an employer. Employment is any service provided by an employee, as defined by common law rules. In 1999, the IRS took the position in Technical Advice Memorandum 199918056 that payroll service companies should not aggregate the wages from multiple common law employers when computing the FICA and FUTA tax wage caps.

Cencast Services LP is a payroll service company for motion picture and television production companies. The production companies hire and supervise the workers; however, Cencast pays the workers, files payroll tax returns, and remits payroll taxes to the IRS for them. From 1991 to 1996, Cencast treated each employed production worker as its employee, and as a result, Cencast aggregated the annual wages paid to an employee and then applied the FICA and FUTA wage caps to each worker’s total wages from all production companies rather than to the wages earned at each company. In 2001, the IRS assessed FUTA tax and FICA tax deficiencies of approximately $43.7 million and $15.6 million, respectively, for tax years 1991–1996, on the basis that each production company was the employer for purposes of computing the wage caps. Cencast later litigated the issue, but the Court of Federal Claims agreed with the IRS. When the parties later engaged in settlement discussions, Cencast argued, for the first time, that some of the employees should be classified as independent contractors. After another round of litigation, the Claims Court barred as untimely Cencast’s independent contractor argument. Cencast appealed both decisions.

The appellate court agreed with the IRS on both issues. Cencast argued the FICA and FUTA tax liabilities are imposed only on the entity that pays the wages. The court agreed that the statutory employer is an employer required to remit the taxes; however, it held the computation of the FICA and FUTA taxes is based on wages from employment, and it is the common law employer that provides that employment. Since the FICA and FUTA wage caps are defined as a portion of the remuneration for employment, the wages earned from the common law employer are the measure of the FICA and FUTA wage caps, according to the court. The court added that applying the wage caps as Cencast desired would make no sense, since common law employers could reduce their FUTA and FICA taxes by using companies such as Cencast, a result Congress could not have intended.

The appellate court also held Cencast’s attempt to argue that some of the employees should be classified as independent contractors was untimely because Cencast could have raised the issue at multiple points over many years and failed to do so.

Cencast Services LP, No. 2012-5142 (Fed Cir. 9/10/13), aff’g 94 Fed. Cl. 425 (2010)

By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota–Duluth.

