Social Security Strategy: It’s a Dicey Question

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: Your question is perhaps one of the diciest this column has received in a long while. And the answer may shock even those readers who think they know just about all there is to know about tax law.

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% 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 a minimum of 10 years, she is entitled to spousal and widow’s benefits.

For example, if you were entitled to receive the $1,000 maximum monthly benefit now available to Social Security recipients, your wife would get $500 per month at age 65. But if your wife wants to get the largest possible 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% of the benefits, since she already gets 50% as your spouse. (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 strictly 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 don’t have a problem with the strategy. But that cannot be said for the Internal Revenue Service.

According to the IRS, you are engaged in tax fraud because evading Social Security taxes is just as illegal as evading income taxes. The IRS claims 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, at the very least, be required to repay back taxes, plus interest, penalties and fines. In the worst case, you could be subject to criminal prosecution. The IRS is loathe to make any exceptions.

However, one of our tax experts, Palm Springs accountant Howard Gordon, argues that there is more to be said on the subject. In fact, Gordon notes that the IRS’s staunch position may be less than fair 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 form a partnership--and put up with the extra accounting hassles that brings--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% contributor to the business, the IRS considers the venture to be the husband’s. For a full reading on this pre-women’s liberation section of the law, consult Section 1402 of the Internal Revenue Code.

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

However, before rushing to opt out of Social Security, be advised that the program does have 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. Finally, there is the matter of marital stability. If you opt for spousal benefits, be sure your marriage will last at least 10 years. Anything less disqualifies you for them.

Property Transfer--It’s a Matter of Timing

Q: I was given some commercial property by my parents in 1983 when it was worth far less than $1 million. Yet the property taxes on this real estate have skyrocketed. I thought real estate transfers between parent and child were exempt from reassessment for property tax purposes. --S.K.

A: The California law exempting certain real estate transfers between parent and child from property tax reassessment was approved by the voters as Prop. 58 on Nov. 4, 1986, and took effect two days later. Transfers completed before that date are not covered.

The law contained in that initiative allows parents and children to transfer between them principal residences plus other real estate with an assessed value of up to $1 million in value without triggering a property tax reassessment. Such transfers are not exempt from gift tax and other applicable tax laws, only property tax reassessments in California.

The law specifies that the maximum limit on real estate that is not a personal residence is $1 million in assessed value--not market value. Almost always, properties in these transfers carry an assessed value far less than their market value.