Services performed after March 31, 1986, by an employee who was hired by a state or political subdivision employer before April 1, 1986, are exempt from mandatory Medicare tax if the employee is a member of a public retirement system and meets all of the following requirements:
- The employee was performing regular and substantial services for remuneration for the state or political subdivision employer before April 1, 1986,
- The employee was a bona fide employee of that employer on March 31, 1986,
- The employment relationship with that employer was not entered into for purposes of avoiding the Medicare tax, and
- The employment relationship with that employer has been continuous since March 31, 1986. In general, the following employment changes are considered continuous employment and would qualify for the exception:
- From a state agency to another state agency in the same state.
- From an employer of one political subdivision to an employer in the same political subdivision.
The following are not considered continuous employment for this purpose:
- From a state agency to a political subdivision of that state.
- From a political subdivision to a state agency.
- From one political subdivision to another.
- From a state agency to an agency of another state.
When a government entity joins in a consolidation, or is taken over in an annexation, the status of its former entity’s pre-April 1, 1986 hires is determined by whether there was a continuous employment relationship. For example, if an elementary school district and a high school district combine into a new entity, a consolidated school district, then the continuing employment exemption applies to employees of both districts.
More information about the application of the Continuing Employment Exception for Medicare can be found in Revenue Ruling 86-88 and Revenue Ruling 88-36. These rulings appear in the Appendix of Publication 963.