By Nancy G. Hilu, Edward M. Bernard, Hanson Bridgett LLP
Social Security coverage rules for state and local government employees are complex, leaving special districts the daunting task of sorting out which employees are covered by the federal system and then properly withholding and reporting Social Security taxes for them. Adding to these challenges, CalPERS, the appointed Social Security Administrator for the State of California, has recently begun questioning public agencies about Social Security coverage issues based on information provided in the Annual Information Request (AIR) that public agencies are required to complete each year. If left unresolved, the uncovered noncompliance issues can lead to adverse tax consequences or loss of Social Security benefits. What follows are a few best practices that can help employers avoid these negative outcomes.
Public Employee Social Security Coverage Basics
About a quarter of all state and local government employees participate in a public retirement system instead of Social Security.[1] Public agencies that offer a retirement system and provide Social Security coverage to its retirement system-eligible employees in addition to their public retirement system benefits must do so through a modification to the State of California’s Section 218 Agreement with the Social Security Administration (SSA).
CalPERS’ Role and the Annual Information Request
As the California State Social Security Administrator, CalPERS performs a number of functions including management of the 218 Agreement modification process. CalPERS is also responsible for collecting information required by SSA from California public agencies. CalPERS uses the AIR to compile data about a public agency’s Social Security or Medicare tax withholding and reporting practices for the SSA. All California public agencies must submit an AIR form to CalPERS annually, regardless of Social Security coverage.
Commonly Identified Social Security Coverage Issues
Recently, CalPERS began questioning public agencies about Social Security coverage issues based on information provided in their AIRs. Common errors discovered by CalPERS during their examinations include:
- Failure to withhold Social Security tax for rehired annuitants when required to do so under a Section 218 Agreement.
- Withholding Social Security tax based solely on agreement in an MOU to provide Social Security coverage (i.e., Section 218 Agreement modification is not obtained).
- Component of a city or county becomes a separate special district and continues the city or county's Social Security and Medicare tax withholding and reporting practices without obtaining its own Social Security coverage through a Section 218 Agreement modification.
- Failure to obtain a Section 218 Agreement modification after the merger of two or more government agencies.
Potential Consequences
Not only is the additional CalPERS scrutiny unnerving, if any Social Security coverage issues discovered by CalPERS during its investigation are not resolved, it can potentially lead to a number of significant adverse consequences for the public agency and its employees, including:
- Referral to the IRS for an employment tax audit – If Social Security tax was withheld without a Section 218 Agreement modification and the district fails to take corrective action, the IRS may refund the Social Security taxes it paid for open tax years.
- Loss of Social Security coverage – If a special district fails to obtain a Section 218 Agreement modification after withholding and reporting Social Security taxes without one, the SSA may deny Social Security credits for service with the district.
- Windfall Elimination Provision (WEP) – Unless an exception applies, Social Security benefits for employees who have also worked in the private sector may be reduced if they earn a pension for public-sector work not covered by Social Security.
- Denial of Social Security disability benefits – If Social Security tax was withheld without a 218 Agreement modification and the district fails to obtain one, employees who continue to be employed with the district and become disabled may be denied Social Security Disability benefits.
- Potential litigation for improper wage withholding or denied benefits – If Social Security tax is improperly withheld from employees’ wages or Social Security benefits are reduced or denied as a result of a district’s failure to timely obtain a Section 218 Agreement modification, employees or former employees may sue the district to make them whole.
Best Practices
Given the potential adverse consequences associated with Social Security coverage errors, special districts may wish to consider taking the following best practices:
- Determine whether they are withholding Social Security taxes for employees covered by a retirement system.
- If withholding Social Security taxes for employees covered by a retirement system, confirm those employees are covered by a Section 218 Agreement modification. A special district can confirm this by registering for a MyCalPERS account to obtain a copy of its Section 218 Agreement modification or, alternatively, by requesting a copy from the CalPERS State Social Security Administrator division.
- Review the modification and work with human resources and payroll to ensure the district's Section 218 Agreement modification is being administered properly.
- If the district determines Social Security taxes are being withheld for retirement-system eligible employees without a Section 218 Agreement modification or with one that doesn't cover those employees, work with CalPERS to initiate the modification process. The process is extensive, may require the district to successfully conduct an employee referendum, and can easily take between twelve and eighteen months to complete. Depending on the extent of coverage being sought (i.e., retroactive to the date of error, a specific number of years or prospective), there are a number of modification options.
In conclusion, the Social Security coverage rules for public agencies are quite complex and can be overwhelming to navigate. Special districts may benefit from consulting with tax or benefits counsel to assist in assessing compliance with the Social Security rules and identifying options to correct any noncompliance issues.
For more information about how to approach Social Security coverage issues, please contact Nancy Hilu at nhilu@hansonbridgett.com or Edward Bernard at ebernard@hansonbridgett.com.
[1] Beginning July 2, 1992 state and local government employees who are not members of a qualifying retirement system are subject to mandatory Social Security coverage.