[Federal Register Volume 76, Number 211 (Tuesday, November 1, 2011)]
[Rules and Regulations]
[Pages 67363-67366]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-28176]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 31 and 301

[TD 9554]
RIN 1545-BJ07


Extending Religious and Family Member FICA and FUTA Exceptions to 
Disregarded Entities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final and temporary regulations 
amending 26 CFR parts 31 and 301. These regulations extend the 
exceptions from taxes under the Federal Insurance Contributions Act 
(``FICA'') and the Federal Unemployment Tax Act (``FUTA'') under 
sections 3121(b)(3) (concerning individuals who work for certain family 
members), 3127 (concerning members of religious faiths), and 3306(c)(5) 
(concerning persons employed by children and spouses and children under 
21 employed by their parents) of the Internal Revenue Code (``Code'') 
to entities that are disregarded as separate from their owners for 
federal tax purposes. The temporary regulations also clarify the 
existing rule that the owners of disregarded entities, except for 
qualified subchapter S subsidiaries, are responsible for backup 
withholding and related information reporting requirements under 
section 3406. The text of the temporary regulations also serves as the 
text of the proposed regulations set forth in the notice of proposed 
rulemaking on this subject in the Proposed Rules section in this issue 
of the Federal Register.

DATES: Effective Date: These regulations are effective on November 1, 
2011.
    Applicability Date: For dates of applicability see Sec. Sec.  
31.3121(b)(3)-1T(e), 31.3127-1T(d), 31.3306(c)(5)-1T(e), 301.7701-
2T(e)(5).

FOR FURTHER INFORMATION CONTACT: Joseph Perera (202) 622-6040 (not a 
toll free call).

SUPPLEMENTARY INFORMATION:

Background

    This document contains final and temporary regulations amending the 
Employment Tax Regulations (26 CFR part 31) and the Procedure and 
Administration Regulations (26 CFR part 301) to extend the FICA and 
FUTA exceptions for family members and religious sect members to 
certain entities that are disregarded as separate from their owners for 
federal tax purposes under Sec.  301.7701-2(c). Section 301.7701-
2(c)(2)(i) provides that generally, except as otherwise provided, a 
business entity that has a single owner and is not a corporation under 
Sec.  301.7701-2(b) is disregarded as an entity separate from its 
owner. Prior to 2009, single-member entities disregarded as separate 
from their owners were generally disregarded for employment taxes and 
certain other requirements of law arising under subtitle C. An employer 
is generally defined as the person for whom an individual performs 
services as an employee. Sections 3401(d), 3121(d), and 3306(a). Prior 
to 2009, the owner of the disregarded entity was treated as the 
employer for purposes of employment tax liabilities and all other 
employment tax obligations related to wages paid to employees 
performing services for the disregarded entity.

[[Page 67364]]

    Recent changes to Sec.  301.7701-2(c)(2)(iv) provide that, with 
respect to wages paid after December 31, 2008, a disregarded entity is 
treated as a separate entity for purposes of employment taxes imposed 
under Subtitle C and related reporting requirements. In addition, the 
separate entity is treated as a corporation for purposes of employment 
taxes imposed under Subtitle C and related reporting requirements. 
Therefore, the entity, rather than the owner, is considered to be the 
employer of any individual performing services for the entity.
    Sections 3111 and 3301 of the Code impose FICA and FUTA taxes, 
respectively, on the employer in an amount equal to a percentage of the 
wages paid by that employer with respect to employment. Under section 
3101, FICA tax is also imposed on the employee. Sections 3121(b) and 
3306(c) define employment for FICA and FUTA purposes as any service, of 
whatever nature, performed by an employee for the person employing him. 
However, there are some services which are explicitly excepted from the 
definition of employment. For example, section 3121(b)(3)(A) provides 
that service performed by a child under the age of 18 in the employ of 
his father or mother is not considered employment for FICA purposes. 
Section 3121(b)(3)(B) provides that service performed by an individual 
under the age of 21 employed by his father or mother, or performed by 
an individual employed by his spouse or son or daughter (subject to 
certain conditions) for domestic service in a private home of the 
employer is not considered employment for FICA purposes. Section 
3306(c)(5) provides that service performed by an individual in the 
employ of his son, daughter, or spouse, and service performed by a 
child under the age of 21 in the employ of his father or mother are not 
considered employment for FUTA purposes.
    Prior to the recent changes to Sec.  301.7701-2(c), the services a 
family member performed for a disregarded entity wholly owned by 
another family member could qualify for the exceptions under sections 
3121(b)(3) and 3306(c)(5) if all the requirements were satisfied, as 
the individual family member owner was treated as the employer. 
However, due to the recent changes to the regulations, family members 
can no longer qualify for the FICA and FUTA exceptions that apply to 
family employment because Sec.  301.7701-2(c)(2)(iv) regards the 
disregarded entity as a separate entity and treats the separate entity 
as a corporation for employment tax purposes. Sections 31.3121(b)(3)-
1(c) and 31.3306(c)(5)-1(c) explicitly state that services performed in 
the employ of a corporation are not within the exceptions from 
employment that apply because of the existence of a family relationship 
between the employee and the individual employing him.
    Section 3127 provides an exception from FICA taxes where both the 
employer and the employee are members of a religious faith opposed to 
participation in the Social Security Act. Both the employer and the 
employee must be members of a recognized religious sect and both must 
have filed and had approved an application certifying that they are 
members of a qualifying religious faith. Prior to the recent changes 
made to Sec.  301.7701-2(c), service performed by a member of a 
qualifying religious sect for a disregarded entity wholly owned by 
another member of a qualifying religious sect could qualify for this 
exception as the individual sect member was considered to be the 
employer. However, as a result of the recent changes to Sec.  301.7701-
2(c)(2)(iv), the disregarded entity is regarded as a separate entity 
for employment tax purposes and the separate entity is treated as a 
corporation. As a corporation, the entity cannot be considered a member 
of a qualifying religious sect. Therefore, the exception cannot apply, 
as the employer would not be a member of a qualifying religious sect.
    Section 301.7701-2(c)(2)(iv) treats disregarded entities as 
corporations for employment tax purposes. Such entities cannot qualify 
for the FICA and FUTA exceptions contained in sections 3121(b)(3), 
3127, and 3306(c)(5) because the individual owner is no longer 
considered the employer. The IRS and the Treasury Department did not 
intend to render these exceptions inapplicable to disregarded entities 
that were eligible for the exceptions prior to the effective date of 
the new regulations in Sec.  301.7701-2(c). The inability of these 
entities to benefit from the exceptions for family employees and 
members of religious faiths has an adverse impact on small businesses. 
Accordingly, a change is necessary to correct this problem.
    While Sec.  301.7701-2(c)(2)(iv) treats an entity that is 
disregarded as an entity separate from its owner as a corporation for 
employment tax purposes, such entity remains disregarded for backup 
withholding and related information reporting purposes. The preamble to 
Treasury Decision 9356, 2007-39 I.R.B. 675, which finalized the changes 
to Sec.  301.7701-2(c) indicates that these regulations do not apply to 
reportable payments under section 3406. Accordingly, the owner of the 
disregarded entity is responsible for any backup withholding that is 
required with respect to reportable payments considered made by the 
owner rather than the disregarded entity, other than a qualified 
subchapter S subsidiary. However, the final regulations themselves do 
not explicitly state that such disregarded entities are not responsible 
for information reporting and backup withholding. This has caused some 
confusion as to the responsible party for filing information returns 
for reportable payments and related backup withholding requirements. 
Therefore, language has been added to these regulations to clarify the 
existing rules with respect to backup withholding and related 
information reporting responsibilities.

Explanation of Provisions

    The temporary regulations would allow certain disregarded entities 
under Sec.  301.7701-2 to qualify for the FICA and FUTA exceptions of 
sections 3121(b)(3), 3127 and 3306(c)(5). The disregarded entity will 
continue to be treated as a corporation for all employment tax 
purposes, except the entity will be disregarded for the limited 
purposes of applying the FICA and FUTA exceptions found in sections 
3121(b)(3), 3127 and 3306(c)(5). For purposes of applying these 
exceptions only, the owner of the disregarded entity will be treated as 
the employer and the employee will be considered to be an employee of 
the owner. Additionally, the regulations clarify the existing rule that 
disregarded entities under Sec.  301.7701-2 are not responsible for 
backup withholding and information reporting of reportable payments 
under section 3406. Rather, the owner of a disregarded entity under 
Sec.  301.7701-2 is responsible for backup withholding and information 
reporting of reportable payments under section 3406. This does not 
change the existing rule.

Special Analyses

    It has been determined that this Treasury Decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It has also been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations, and because the 
regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, this

[[Page 67365]]

regulation will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

Drafting Information

    The principal author of these regulations is Joseph Perera, Office 
of Associate Chief Counsel (Tax Exempt & Government Entities). However, 
other personnel from the IRS and Treasury Department participated in 
their development.

List of Subjects

26 CFR Part 31

    Employment taxes, Income taxes, Penalties, Pensions, Railroad 
retirement, Reporting and recordkeeping requirements, Social security, 
Unemployment compensation.

26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recording requirements.

Amendments to the Regulations

    Accordingly, 26 CFR parts 31 and 301 are amended as follows:

PART 31--EMPLOYMENT TAXES AND COLLECTION OF INCOME TAX AT SOURCE

0
Paragraph 1. The authority citation for part 31 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *


0
Par. 2. Section 31.3121(b)(3)-1 is amended by revising paragraph (c) 
and adding paragraphs (d) and (e) to read as follows:


Sec.  31.3121(b)(3)-1  Family employment.

* * * * *
    (c) [Reserved]. For further guidance, see Sec.  31.3121(b)(3)-
1T(c).
    (d) [Reserved]. For further guidance, see Sec.  31.3121(b)(3)-
1T(d).
    (e) [Reserved]. For further guidance, see Sec.  31.3121(b)(3)-
1T(e).

0
Par. 3. Section 31.3121(b)(3)-1T is added to read as follows:


Sec.  31.3121(b)(3)-1T  Family employment (temporary).

    (a) [Reserved]. For further guidance, see Sec.  31.3121(b)(3)-1(a).
    (b) [Reserved]. For further guidance, see Sec.  31.3121(b)(3)-1(b).
    (c) Services performed in the employ of a corporation are not 
within the exceptions, except as provided in paragraph (d). Services 
performed in the employ of a partnership are not within the exception 
unless the requisite family relationship exists between the employee 
and each of the partners comprising the partnership.
    (d) A disregarded entity that is treated as a corporation under 
Sec.  301.7701-2(c)(2)(iv)(B) of this chapter (Procedure and 
Administration Regulations) shall not be treated as a corporation for 
purposes of applying section 3121(b)(3). For purposes of applying 
section 3121(b)(3), the owner of the disregarded entity will be treated 
as the employer.
    (e) Paragraphs (c) and (d) of this section apply with respect to 
wages paid on or after November 1, 2011. However, taxpayers may apply 
paragraphs (c) and (d) of this section to wages paid on or after 
January 1, 2009.
    (f) Expiration date. The applicability of paragraphs (c) and (d) of 
this section expires on or before October 31, 2014.

0
Par. 4. Section 31.3127-1T is added to subpart B to read as follows:


Sec.  31.3127-1T  Exemption for employers and their employees where 
both are members of religious faiths opposed to participation in Social 
Security Act programs (temporary).

    (a) If an employer (or if the employer is a partnership, each 
partner therein) and their employee are members of a recognized 
religious sect or division described in section 1402(g)(1) of the Code, 
both the employer and employee adhere to the tenets and teachings of 
that sect, and both the employer and employee have filed and had 
approved applications under section 3127(b) for exemption from the 
taxes imposed by sections 3111 and 3101 then the employer is exempt 
from taxes imposed by section 3111 with respect to the wages paid to 
the eligible employee, and the employee is exempt from the taxes 
imposed by section 3101 with respect to the wages paid by that 
employer.
    (b) Services performed in the employ of a corporation are not 
within the exception, except as provided in paragraph (c) of this 
section.
    (c) A disregarded entity that is treated as a corporation under 
Sec.  301.7701-2(c)(2)(iv)(B) of this chapter (Procedure and 
Administration Regulations) shall not be treated as a corporation for 
purposes of applying section 3127. For purposes of section 3127, the 
owner of the disregarded entity will be treated as the employer and the 
payor of the employee's wages.
    (d) This section applies with respect to wages paid on or after 
November 1, 2011. However, taxpayers may apply this section to wages 
paid on or after January 1, 2009.
    (e) Expiration date. The applicability of this section expires on 
or before [October 31, 2014].

0
Par. 5. Section 31.3306(c)(5)-1 is amended by revising paragraph (c) 
and adding paragraphs (d) and (e) to read as follows:


Sec.  31.3306(c)(5)-1  Family Employment.

* * * * *
    (c) [Reserved]. For further guidance, see Sec.  31.3306(c)(5)-
1T(c).
    (d) [Reserved]. For further guidance, see Sec.  31.3306(c)(5)-
1T(d).
    (e) [Reserved]. For further guidance, see Sec.  31.3306(c)(5)-
1T(e).

0
Par. 6. Section 31.3306(c)(5)-1T is added to read as follows:


Sec.  31.3306(c)(5)-1T  Family employment (temporary).

    (a) [Reserved]. For further guidance, see Sec.  31.3306(c)(5)-1(a).
    (b) [Reserved]. For further guidance, see Sec.  31.3306(c)(5)-1(b)
    (c) Services performed in the employ of a corporation are not 
within the exception, except as provided in paragraph (d) of this 
section. Services performed in the employ of a partnership are not 
within the exception unless the requisite family relationship exists 
between the employee and each of the partners comprising the 
partnership.
    (d) A disregarded entity that is treated as a corporation under 
Sec.  301.7701-2(c)(2)(iv)(B) of this chapter (Procedure and 
Administration Regulations) shall not be treated as a corporation for 
purposes of applying section 3306(c)(5). For purposes of applying 
section 3306(c)(5), the owner of the disregarded entity will be treated 
as the employer.
    (e) Paragraphs (c) and (d) of this section apply with respect to 
wages paid on or after November 1, 2011. However, taxpayers may apply 
paragraphs (c) and (d) of this section to wages paid on or after 
January 1, 2009.
    (f) Expiration date. The applicability of paragraphs (c) and (d) of 
this section expires on or before [October 31, 2014].

 PART 301--PROCEDURE AND ADMINISTRATION

0
Par. 7. The authority citation for part 301 continues to read in part 
as follows:

    Authority:  26 U.S.C. 7805 * * *


0
Par. 8. Section 301.7701-2 is amended by:
0
1. Revising paragraph (c)(2)(iv)(A).
0
2. Redesignating paragraph (c)(2)(iv)(C) as paragraph (c)(2)(iv)(D) and 
adding new paragraph (c)(2)(iv)(C).


Sec.  301.7701-2  Business entities; definitions.

* * * * *
    (c) * * *
    (2) * * *

[[Page 67366]]

    (iv) * * *
    (A) [Reserved]. For further guidance, see Sec.  301.7701-
2T(c)(2)(iv)(A).
* * * * *
    (C) [Reserved]. For further guidance, see Sec.  301.7701-
2T(c)(2)(iv)(C).
* * * * *
0
Par. 9. Section 301.7701-2T is revised to read as follows:


Sec.  301.7701-2T  Business entities; definitions (temporary).

    (a) through (c)(2)(iv) [Reserved]. For further guidance, see Sec.  
301.7701-2(a) through (c)(2)(iv).
    (A) In general. Section Sec.  301.7701-2(c)(2)(i) (relating to 
certain wholly owned entities) does not apply to taxes imposed under 
Subtitle C--Employment Taxes and Collection of Income Tax (Chapters 21, 
22, 23, 23A, 24 and 25 of the Internal Revenue Code). However, Sec.  
301.7701-2(c)(2)(i) does apply to withholding requirements imposed 
under section 3406 (backup withholding). The owner of a business entity 
that is disregarded under Sec.  301.7701-2 is subject to the 
withholding requirements imposed under section 3406 (backup 
withholding). Section 301.7701-2(c)(2)(i) also applies to taxes imposed 
under Subtitle A, including Chapter 2--Tax on Self-Employment Income. 
The owner of an entity that is treated in the same manner as a sole 
proprietorship under Sec.  301.7701-2(a) will be subject to tax on 
self-employment income.
    (B) [Reserved]. For further guidance, see Sec.  301.7701-
2(c)(2)(iv)(B).
    (C) Exceptions. For exceptions to the rule in Sec.  301.7701-
2(c)(2)(iv)(B), see sections 31.3121(b)(3)-1(d), 31.3127-1(c), and 
31.3306(c)(5)-1(d).
    (D) through (e)(4) [Reserved]. For further guidance, see Sec.  
301.7701-2(c)(2)(iv)(D) through (e)(4).
    (5) Paragraphs (c)(2)(iv)(A) and (c)(2)(iv)(C) of this section 
apply to wages paid on or after November 1, 2011. For rules that apply 
to paragraph (c)(2)(iv)(A) of this section before November 1, 2011, see 
26 CFR part 301 revised as of April 1, 2009. However, taxpayers may 
apply paragraphs (c)(2)(iv)(A) and (c)(2)(iv)(C) of this section to 
wages paid on or after January 1, 2009.
    (e)(6) through (e)(7) [Reserved]. For further guidance, see Sec.  
301.7701-2(e)(6) through (e)(7).
    (8) Expiration Date. The applicability of paragraphs (c)(2)(iv)(A) 
and (c)(2)(iv)(C) of this section expires on or before [October 31, 
2014].

Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
    Approved: November 19, 2010.
Michael Mundaca,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2011-28176 Filed 10-31-11; 8:45 am]
BILLING CODE 4830-01-P