As a company expands its operations, one common strategy is to form a subsidiary entity that takes on a specific role or function in service to the original enterprise. This action legally creates two separate businesses, which are each responsible for the standard array of business-related taxes, such as Social Security and Medicare. Oftentimes, there will be officers on the payroll for both companies, which could lead to paying higher taxes on any single shared employee. However, the business can work around this circumstance by establishing a common paymaster for both the original and the subsidiary, providing a tax savings to both the employer and the employees.
Social Security and Medicare payroll taxes in 2014 are calculated as follows: 12.4% of an employee’s annual wages go to Social Security (up to $117,000 in wages), and 2.9% of all wages go towards Medicare (no wage limit). The employer and employee each split this obligation 50/50— (7.65% each).
What this means for the business is that for any shared worker being paid separately by both companies, the Social Security tax paid by the company (6.2% of the employee’s wages) will apply to each salary up to $117,000 (meaning 6.2% up to $234,000 if paid by both companies). Additionally, the company would pay 50% of Medicare tax (1.45%) for all employee wages from both companies.
However, if the business establishes a “common paymaster” to handle payroll for both entities, then all wages paid to a single shared employee from both companies will be treated as a single salary…meaning that above the $117,000 in total annual wages, both employer will only be responsible for the 1.45% in Medicare taxes (the employee is responsible for their 1.45% also). Depending on how much the shared employees earn per year, using this common paymaster can represent significant tax savings.
Here’s an example: Donna is a top officer of Company A and its subsidiary, Company B. Donna’s wages from Company A is $100,000; her wages from Company B are $70,000. Without the common paymaster, Company A would pay 6.2% of $100K and Company B would pay 6.2% of $70K since neither wage reach the $117,000 limit separately. The two companies pay a total of $13,005 in taxes (6.2% on $170K plus 1.45% on $170K). However, with common paymaster the companies’ would pay $9,719 (6.2% on $117,000 and 1.45% on $170,000) – a combined savings of $3,286 for the companies with common paymaster.
A business must meet three criteria for this strategy to provide the tax break:
- One of the companies holds at least a 50% ownership stake in the other company.
- The companies share at least 30% of all employees.
- The companies share at least 50% of all officers.
It’s important that all employees—not just shared employees—are paid by this single paymaster. The original business will be in charge of keeping records and maintaining the payroll account.
Note that employees getting paychecks from two or more companies may also be able to claim a tax credit if they paid Social Security tax in excess of the $117,000 ceiling.