Capturing Employment Tax Refunds – Are You Eligible?

At a glance

• The main takeaway: The key to most employment tax refund eligibility is meeting the definition of successorship, but the road to capturing refunds is complex with varying definitions of eligibility for Social Security/FUTA or State Unemployment Insurance tax purposes.  
• Assess the impact: While exploring the employment tax refund applicability in both the federal and state context, it’s important to get help from a trusted advisor to determine and quantify eligibility, document the technical position, and capture the applicable refunds through the amended return process.
• Take the next step: Are you eligible for an employment tax refund? Aprio’s Employment Tax team can help you determine if you meet the definition of successorship, so you can start claiming valuable refunds.

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The full story:

The road to capturing valuable employment tax refunds is complex. If your organization has experienced internal restructurings or acquired/merged with another business or businesses in the middle of a tax year, you may have left money on the table with respect to payroll taxes. Employers, such as yourself, question their applicability for both federal and state employment tax refunds, and internal payroll departments may not be well-versed in the eligibility and recovery requirements. Even third-party payroll providers generally do not advise or actively pursue the opportunities to secure employment tax refunds on behalf of their clients.

However, the key to most refund eligibility is meeting the definition of successorship for employment tax purposes. It is important to note that this definition will vary in terms of eligibility for Social Security/Federal Unemployment Tax Act (FUTA) or State Unemployment Insurance (SUI) successorship. In either instance, qualifying for successorship and being able to capture the refunds are two different forks down a single road.

Federal Successorship (Social Security/FUTA)

Successorship for federal employment tax purposes may generally be met when:

“[An] employer (successor) acquires substantially all the property (1) used in a trade or business of another employer (predecessor), or (2) used in a separate unit of a trade or business of a predecessor, and, in connection with or immediately after the acquisition (but during the same calendar year), the successor employs individuals who immediately prior to the acquisition were employed in the trade or business of the predecessor.” Revenue Procedure 2004-53

While in most cases this seems fairly straightforward, the most common complications arise in two instances:

1. When only a portion of a business is acquired, say one manufacturing facility out of three, or if one division of employees is transferred to a new entity, the thought is often that successorship is not met because ALL of the assets/employees did not move in the transaction. Note the second qualifier above, i.e. the transfer of a separate unit of a trade or business to another employer. Consider prior transactions where only portions of another business, or a division in an internal reorganization was transferred.
2. Moving business and employees between payroll systems as a result of a transaction often makes real-time continuation of year-to-date (YTD) taxable wage bases impossible or too time consuming to implement. This does not mean that successorship is not met, and refunds are often left on the table because of system constraints that may be mitigated because of the post- transaction refund process.

The statute of limitations on capturing prior period federal employment tax refunds is three years from the due date of filing Forms 941 for the applicable tax year. The earliest open year for filing refunds via Form 941-X is 2021, since the 2021 Forms 941 were due by April 15, 2022, expiring April 15, 2025. Form 940 is due January 31 of the tax year, so the statute of limitations for FUTA (Forms 940) refunds runs back to 2021, with a deadline of January 31, 2025.

State Unemployment Insurance Successorship (SUI)

SUI tax successorship is often more complicated than federal employment tax because the definition of successorship varies from state-to-state, as do statutes of limitations and deadlines for requesting successorship. There are also potential negative consequences in being considered, or accepting, successorship for SUI purposes since the carry-over of YTD wages could also entail accepting the prior employer’s unemployment experience. Sometimes a short-term gain in YTD taxable wage base continuation can be negated by a longer-term increase in unemployment tax rates. As a result, prospective and prior period successorship positions should be considered on a state-by-state basis, and include an in-depth review of unemployment tax rates, recent history (e.g. has the prior company experienced layoffs that will impact the SUI rates in the future but are not included in the rate structure yet), and impact via state law.

In the event of an internal transfer of employees between legal entities, successorship almost always applies and is generally mandatory, with some notable exceptions, and should be considered for both taxable wage base and experience rate transfer purposes.

Next Steps

In exploring refund applicability in both the federal and state context, it is important to note you may need help from the predecessor to quantify and capture the refunds, or at least gain access to payroll records in the event of an unrelated party transaction. That is to say, in order to take advantage of the taxable wage base carryover afforded by successorship, you will generally need to have the YTD taxable wages paid to the employees’ pre-transaction to file for the refunds.

While there are myriad of issues to be concerned with in the payroll tax space, not to mention day-to-day payroll processing, it may be worthwhile to take a step back and look at transactions back to 2021 and see if hidden opportunities are on the table.

Feasibility is a fairly easy process and recovery can be a bit complex, but capturing cash from historical transactions can certainly be gratifying.

The bottom line

Aprio’s Employment Tax team has vast experience in the world of employment tax. We can help you determine your eligibility in claiming a refund by meeting the definition of successorship for employment tax purposes.