Before sidestepping Social Security taxes, make sure that you qualify

YOUR MONEY

September 06, 1992

Q: My wife and I are independent real estate agents employed by the same brokerage. I declare all our commissions under my name so we both do not have to pay Social Security taxes. My wife thinks this may not be in her best interest since she will not have contributed sufficient taxes to qualify for benefits on her own account. Is she right? Should we split our income, which now exceeds $110,000 per year, and each pay the maximum Social Security taxes?

B. S. P.

A: According to the Social Security Administration, your strategy may make financial sense. After all, if you and your wife are married for at least 10 years, she will be entitled to receive half of your benefits upon turning age 65 -- without ever having paid a cent into Social Security on her own account.

She would also qualify for 100 percent of your monthly benefits as your widow when you die -- again regardless of whether she had ever paid into Social Security. Even if you divorce, so long as you are married for at least 10 years, she is entitled to spousal and widow's benefits.

For example, if you were entitled to the $1,000 maximum monthly benefit now available to Social Security recipients, your wife would get $500 a month at age 65. But if your wife wants the largest monthly benefit as well, she would have to pay the maximum tax herself; this year the maximum Social Security and Medicare contribution for self-employed workers is $10,657.

What does your wife get for paying the maximum? Her benefits would double, but she would be paying as much as you for just 50 percent of the benefits, because, as your spouse, she already gets 50 percent. (By the way, this scenario would be true if your wife paid the full Social Security tax each year and you paid nothing in the expectation of claiming a spousal benefit.)

Looking at the mathematics, it's easy to understand why independent agents and self-employed people do what you and your wife are doing. And Social Security officials say they have no objection to the strategy. But the Internal Revenue Service says you are engaged in tax fraud because evading Social Security taxes is just as illegal as evading income taxes. The IRS says that as real estate agents for the same brokerage, you are not truly self-employed but rather separately drawing commission checks from the same source. IRS representatives say that if you are discovered and successfully challenged, you could be required to pay back taxes, plus interest, penalties and fines.

But one of our tax experts, Howard Gordon, an accountant in Palm Springs, Calif., notes that the IRS' position may be unfair when viewed in light of its position on tax deductions permitted to married couples who jointly own a small business. In this case, the law is clear that unless the couple forms a partnership -- and puts up with the accounting hassles -- any income and business expense deductions generated by the business belong to the husband, regardless of the wife's contribution to the effort.

(The only exception is when the wife virtually runs the business by herself. In this case, the income and deductions are deemed to be hers alone.) But if the husband and wife are equal partners or if the wife is a 30 percent contributor, the IRS considers the venture the husband's. (Consult Section 1402 of the Internal Revenue Code.)

What does this mean to you? For starters, Mr. Gordon says you and your wife should determine whether you are partners or simply independent agents working for the same employer. Do you work on the same listings together? If so, Mr. Gordon says a case could be made for considering yourselves business partners and treating your income and tax deductions as outlined in Section 1402.

But before opting out of Social Security, be advised that the program has some major benefits. Qualified contributors are eligible for disability coverage and their own full retirement (not spousal) benefits as early as age 62. Opting to draw spousal benefits means that you must wait until your spouse retires or turns age 70, whichever comes first.

Carla Lazzareschi will respond in this column to questions of general interest. Please do not telephone. Write to Your Money-Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.

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