Payroll Brass Tax: Payroll Consolidations and Strategies for Multi-Entity Employers

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Mike Mahoney: Welcome to this month’s installment of Payroll Brass Tax, the podcast where we discuss hot topics and employment taxes. I’m your host, Mike Mahoney, a shareholder in Ogletree’s Morristown, New Jersey, office and the chair of the Employment Tax Group. Today we’re tackling a question we get from clients all the time. Can we simplify our payroll? If your organization runs dozens of legal entities, each with its own EIN, its own quarterly filings, and its own W-2s, you know how painful that can be. I’m joined today by my colleague, Megan Mengüç, an associate in our Washington DC office who works with me on these matters regularly. Megan, thanks for being here.

Megan Mengüç: Thanks, Mike. Happy to be here. This is the topic I really enjoy digging into with clients.

Mike Mahoney: So, let’s start at the top. When we talk about consolidating payroll across related entities, what exactly do we mean?

Megan Mengüç: At a high level, it means reducing the number of federal employer identification numbers referred to as EINs, that a company uses to report and deposit employment taxes. A lot of our clients have complex structures with dozens or even over a hundred legal entities. Think hospital systems, franchise groups, or private equity portfolio companies. But only a fraction of those entities have their own EINs that are truly necessary from an operational standpoint. Every extra EIN means another quarterly Form 941 filing, another set of W-2s, another state withholding registration, and so on. Consolidation is about streamlining all of this so the payroll team isn’t buried in filings and reconciliation work.

Mike Mahoney: That makes perfect sense. I know we’ve discussed that there are really three main paths we walk clients through. Let’s take them one at a time here. The first one we see a lot of questions about is the captive employee leasing arrangement. Can you break that down?

Megan Mengüç: Sure. A captive leasing arrangement is where you set up or designate a single entity inside of your control group to be the common law employer of all the workers. That entity then leases the employees back to the operating companies under an intercompany services agreement. Because there’s now one employer, you get the most comprehensive consolidation available. 1941, 1940, consolidated state unemployment in most states, and importantly, the FICA wage base doesn’t restart when employees work across entities.

Mike Mahoney: So, that really sounds like a home run, but I’m a little hesitant. What’s the catch here?

Megan Mengüç: There are a few. First, the leasing entity has to be genuinely the common law employer. It has to hire, train, direct, and control the employees. If the operating companies are still running things day-to-day, such as keeping their own assets, contracts, and management, then the IRS and state agencies may say that the employees really still belong to those operating companies, and that unravels the whole structure. Second, state unemployment agencies have increased their scrutiny of these arrangements. Some states won’t recognize the leasing entity as the employer, for state unemployment tax purposes. Third, many states regulate employee leasing and impose licensing and bonding requirements. This means you may be stepping into a PEO regulatory regime. So, in all, the captive leasing arrangement is a powerful option, but it comes with real implementation risk.

Mike Mahoney: Got it. Let’s pivot a little bit to the second approach. The second approach is a Section 3504 agent reporting arrangement. How does that work and how is it different from a captive leasing arrangement?

Megan Mengüç: The difference is that section 3504 agent reporting preserves the existing employment relationships. Nobody changes employers. Instead, one entity in the group is authorized by the IRS to act as the agent. That agent files a single aggregated 941 each quarter on behalf of all the participating employers. And in order to enter into this relationship, each employer initially files a Form 2678 to appoint the agent. Once the IRS approves it, the agent reports and deposits FICA and federal income tax withholding under on EIN. The agent also files consolidated W-2s, and in most states, consolidated state income tax withholding.

Mike Mahoney: And what are the limitations with a Section 3504 agent arrangement?

Megan Mengüç: The main one is that it doesn’t cover everything. FUTA, the Federal Unemployment Tax still has to be filed by each individual employer under its own EIN. Same with state unemployment taxes. And because each entity is still a separate employer, the FICO Social Security wage base restarts if an employee moves between entities or works for more than one. You also need to file a Schedule R each quarter, which allocates wages and taxes back to each employer, and not every payroll platform supports that well. But for a company whose primary goal is reducing the volume of quarterly 941 filings and W-2s, it’s typically a practical low risk path.

Mike Mahoney: The third option is the common paymaster. Where does that fit into all of this?

Megan Mengüç: The common paymaster comes from section 3121S of the code. It’s really targeted at one specific problem. The FICA and FUTA wage-based restart for employees who work for more than one related corporation in a consolidated group at a time. Here’s how it works. If you have someone who’s concurrently employed by two or more related entities, and one of those entities is designated as the common paymaster, then for wage-based purposes, those employers are treated as a single employer. This eliminates the double social security tax.

Mike Mahoney: So, what’s the downside with the common paymaster arrangement?

Megan Mengüç: Scope. It only applies to concurrently employed workers. This means that the employee has to be performing substantial services for each employer, not just be nominally on payroll. For most companies, that’s a small slice of the workforce. It doesn’t help them consolidate EINs or reduce filings for the rest of their employees. And more than half the states don’t permit common paymaster treatment for state unemployment. So, it’s a useful tool in the toolkit, but it’s rarely a standalone solution.

Mike Mahoney: Now, one thing I always tell clients is that there’s no one-size-fits-all answer here. Can you talk about why the facts and circumstances matter so much?

Megan Mengüç: Absolutely. And this is really the heart of the advisory work. The right approach depends on what the company is trying to achieve. If the primary driver is administrative simplification, such as having fewer filings, then section 3504 agent reporting usually gets you there. If the company has a large number of concurrently employed workers and the FICA savings are meaningful, then a common paymaster layout might be worth adding on top. And if the organization is open to restructuring and has the appetite for a longer-term project, captive leasing or even merging entities could deliver the most complete consolidation. Some clients end up with a blended approach. Agent reporting for most entities, combined with targeted entity consolidation where it makes sense. The point is you have to map the structure to the company’s goals, its workforce, and its risk tolerance.

Mike Mahoney: Those are great points. And before we wrap up, I want to make sure we flag something important. Payroll consolidation isn’t just an employment tax question, is it?

Megan Mengüç: Not at all. Anytime you’re changing how payroll is reported, you need to think about the ripple effects across the business. Healthcare and other professional licensing requirements may be tied to a specific employing entity. Employment agreements, union contracts, and work visas all reference a particular employer. Retirement plans and health and welfare benefit plans also may need to be amended. You can even bump into sales tax and state income tax apportionment issues if payroll is shifting between entities. So, our strong recommendation is to approach this as a cross-disciplinary project.

Mike Mahoney: That’s great advice, Megan. As always, the details matter, and getting the right team around the table early saves a lot of headaches down the road. Thank you to our listeners for tuning into Payroll Brass Tax. We hope you found this episode informative. If you have any questions on this topic or topics you’d like us to cover in future episodes, please feel free to reach out. Until next time, take care.

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