What is a “public retirement system” as defined by the IRS?

What is a “public retirement system” as defined by the IRS?  A “public retirement system (sometimes referred as a “FICA replacement system or plan) is a pension plan maintained by a public employer that meets the requirements of Internal Revenue Code 3121(b)(7)(F).  These requirements must be met as an alternative to mandatory social security coverage. A retirement system may be a pension, annuity, retirement or similar fund or system established by a state or political subdivision.

The system does not have to be a state creation, nor does it have to be a plan under which the benefits are guaranteed by the state constitution.  A retirement system can include a group annuity purchased by the state or political subdivision from a private insurance company.  Whether a system qualifies as a “public retirement system” does not depend on whether it meets the requirements within the Employees’ Retirement Income Security Act of 1974 or commonly referred to as ERISA.

What does it mean to be a qualified participant in a retirement system? To be a qualified participant, a member must actually participate in the system.  An employee who is eligible for an optional system, but decides not to participate, will be subject to mandatory social security tax.

How are part-time, seasonal and temporary workers defined for purposes of determining whether they are qualified participants in a public retirement system under Internal Revenue Code section 3121? A part-time employee normally works 20 hours or less per week.  A seasonal employee may work full-time, but for less than five months a year.  In the case of teachers above the high school level, part-time is defined as less than one-half the classroom hours designated as full-time by the school.

A temporary employee performs services under a contractual agreement arrangement of two or less years.  Remember this does not apply when future contract extensions on an average of 80 percent of similarly situated employees have had bona fide offers to renew their contracts in the immediately preceding two academic or calendar years, or the contract history of a particular employee indicates that the employee is not a temporary employee.

For new employees, entering a retirement system, is there any waiting period for coverage in which social security does not have to be paid? If a full-time employee can be enrolled in the plan by the first day of the first full calendar month of service, social security taxes do not have to be paid during the partial month in which he or she begins work.  This rule does not apply to part-time, seasonal, and temporary employees.

Is a retirement system that does not cover all employees a “retirement system” within the meaning of Regulations 31.3121? A retirement system is not required to cover all employees; it may be a retirement system for some employees and not others.  The coverage determination is made separately for each individual.

A teacher who is a participant in a retirement system during the academic year also works a few hours per week in the summer in the school library.  The library job is not covered by a Section 218 Agreement or by the public retirement system because it does not fall during the normal 10-month school year.  Are the wages for the summer job subject to social security or Medicare taxes?  Not for social security but possibly Medicare.  The wages are not subject to social security taxes because the teacher is a qualified participant in the public retirement system with respect to her full-time job.  The Medicare tax applies, unless the employee was hired prior to April 1, 1986, and qualifies for the continuing employment exception.

We have discussed Revenue Procedure 91-40 that defines rules relating to the minimum retirement benefit requirement prescribed under 31.3121(b)(7)-2 of the Employment Tax Regulations.  We have discussed the ways government employers and employees participate in social security and/or Medicare as well as when the employers and employees are exempt from social security if participating in a FICA replacement plan as qualified participants.