TN 2 (02-08)

A. The Continuing Employment Exception

Most State and local government employees hired or rehired beginning April 1, 1986 are mandatorily covered for Medicare. When Congress extended mandatory Medicare coverage to State and local government employees, it recognized that mandatory Medicare coverage for all State and local government employees could impose a significant financial burden on the various State and local governmental entities. To prevent this from happening, Congress provided a continuing employment exception to mandatory Medicare coverage for those employees in “current employment which continues” 26 U.S.C. 3121(u)(2)(C) (1988).

Section 3121(u)(2)(c) of the Internal Revenue Code (IRC) contains the continuing employment exception for services performed by State and local government employees hired before April 1, 1986. Those employees hired before April 1, 1986 are excluded from mandatory Medicare coverage provided that they were

• Performing regular and substantial services for pay before April 1, 1986

• Bona fide employees before April 1, 1986

• Hired for purposes other than avoiding Medicare taxes

• And have not either on April 1, 1986 or later terminated the employment relationship with the employer.

The status of a former government entity’s pre-April 1, 1986 hires when that entity joins in a consolidation (or hybrid consolidation) or is taken over in an annexation or goes through a miscellaneous transition is determined by whether there was a continuous employment relationship. We reference two important cases for guidance.

B. Examples

1. Board of Education of Muhlenberg County, Kentucky vs. United States of America, 920F.2d 370 (6th Cir. 1990)

Effective July 1, 1986, three rural western Kentucky school districts – Muhlenberg County School District, Central City Independent School District, and the Greenville Independent School District – consolidated into one post-consolidation district called the Muhlenberg County School District, which, although keeping the name and employer identification number of the old Muhlenberg County school system, considered itself a new entity.

The newly consolidated Muhlenberg County School District assumed all the assets and liabilities of the three pre-consolidation school districts, including contractual obligations. Each of the pre-consolidation school boards was given representation on the post-consolidation school board, and the teachers of the three pre-consolidation school districts had no interruption of employment, no termination, no transfer and retained their continuing contract status. For these reasons, the post-consolidation Muhlenberg County School District did not consider the employees of the pre-consolidation school districts as being new hires to be covered under the mandatory Medicare provisions.

The U.S. Government, on the other hand, viewed the old Muhlenberg County school system as continuing to exist after the consolidation but considered the Greenville and Central City school systems to have been dissolved and held that the former Greenville and Central City employees were new hires of the Muhlenberg County School district as of July 1, 1986, and must be covered for mandatory Medicare and pay the requisite taxes.

In its December 3, 1990 decision, the U.S. Court of Appeals for the Sixth Circuit held that the language of the continuing employment exception did not expressly address the results of a consolidation. After reviewing the legislative history of mandatory Medicare coverage and the continuing employment exception, the Court sided with the Muhlenberg County School District and concluded that it was not Congress’ intention “to treat a merger or consolidation as creating a new employer” for purposes of IRC Section 3121(u)(2)(C) because such treatment would create the same, sudden financial burden on state and local governments that the exception was drafted to mitigate, and would deter consolidation of local government entities for purposes of enhancing efficiency.

Accordingly, the court held that the consolidated school system was not a new employer for its post-consolidation employees, who in substance worked continuously for the same employer under a different name.

2. Regan vs. United States, 421 F. Supp. 2d 319 (D Mass. 2006)

Although the Muhlenberg case dealt specifically with a consolidation situation, the Regan case viewed Muhlenberg as being instructive when considering the status of the employees of a governmental entity annexed by another such entity.

The Commonwealth of Massachusetts passed various statutes between 1996 and 2000 which abolished the county governments in seven counties. The county government employees were transferred to State employment with no impairment of employment rights, without interruption of service, without impairment of seniority, retirement or other rights of employees, and without reduction in compensation or salary grade. Additionally, the Commonwealth paid all the liabilities and assumed the leases and contracts of the abolished counties.

In its March 14, 2006 decision, the United States District Court for the District of Massachusetts acknowledged that IRC Section 3121 did not provide a clear answer as to whether the State would be considered a new employer and the previously excepted county employees treated as newly hired when the State abolished a county government and brought employment relationships under its control.

From its review of the legislative history of mandatory Medicare and the continuing employment exception as well as other sources, such as the Muhlenberg case, the court ultimately determined it was not the intent of Congress to treat an annexation or consolidation as creating a new employer for the purposes of the mandatory Medicare provisions because such treatment would create a sudden financial burden on State and local governments that would be inconsistent with the policy decision Congress made when it created the continuing employment exception. Accordingly, the court ruled in favor of the Commonwealth’s position that its actions to annex the seven county governments did not render the county employees newly hired nor could the Commonwealth/State be considered a new employer for the purposes of the continuing employment exception. The court concluded that the annexation did not interrupt the continuity of employment for the continuing employment exception.

C. The Continuing Employment Exception Status in Predecessor-Successor Situations

By establishing the continuing employment exception to mandatory Medicare, Congress was attempting to provide a gradual process of including employees in the Medicare system and avoid a sudden financial burden for governmental employers, which could, in turn, deter the joining of local government entities for purposes of enhancing efficiency.

1. Consolidations and Hybrid Consolidations

Employees of a governmental entity hired prior to April 1, 1986, who were exempt from mandatory Medicare coverage due to the continuing employment exception, continue to be exempt if the governmental entity is subsequently involved in a consolidation or hybrid consolidation situation.

2. Annexations

The continuing employment exception to mandatory Medicare applies to the pre-April 1, 1986 hired employees of a governmental entity which is being annexed, even if it is a local governmental entity that is being annexed by the State government.

3. Miscellaneous Transitions

Due to the nature of a Miscellaneous Transition – the change in form and substance of an existing governmental entity – there is no interruption or termination of the employment relationship, and the continuity of employment is not interrupted. The pre-April 1, 1986, hired employees would continue to be exempt from the mandatory Medicare coverage provisions.