Is S-Corp Income to SS recipient?

[Zee]

I asked this question with another in the "Sweat Equity" thread. So, please forgive the repetition.

Taxmandan indicated it is, "SSA is aware of the various attempts to evade the income limits using business entities in an attempt to recharacterize income. They will notice, and the penalties are stiff".

Here's the situation again. Let's assume a newly formed S Corporation "gifts" shares in return for "sweat equity" to the taxpayer. The business is highly seasonal. In addition to the shares, the "sweat equity" owner will be paid $12,960 (the SS limit before earnings are adjusted for those under full retirement age) to manage the business. The $12,960 is reasonable compensation for the seasonal services (maybe even a little high). Of course, the dollar amount used wouldn't be exactly the limit. It's unlikely the firm will make a profit the first year of operation.

In the situation described, the gift of shares most likely will not be a taxable even, right?

Is Taxmandan correct? Would the distributive share of any profit be considered earnings for social security benefit earnings restrictions? What about a loss? Would it be subtracted from the W2 earnings for this purpose (ie, would a $10,000 loss reduce the reported earnings for the limitation only to $2,960?).

I haven't been able to get an answer from the Social Security folks. So, thanks in advance for any help provided.

[Taxref]

I think the first point to address is the gift of shares. Since the stock is being worked for, there is no gift. You have taxable wages in such a case.

Your client does run some risk on several grounds. As Taxmandan stated, it is possible that SSA may consider all distributions taken to be attempts to circumvent the earnings limits. It is also possible that SSA may even consider your client to be not retired and disallow his RSDI entirely. I have not seen that issue in a few years, but several of my clients had to fill out SSA questionaires which warned of that possibility. They (SSA) can apply different definitions of being retired to business owners than to former W2 employees.

Finally, S corporation losses are not subtracted from W2 earnings to determine earnings for RSDI purposes. The profit/loss from S corporations are considered unearned income.

[Zee]

I think the first point to address is the gift of shares. Since the stock is being worked for, there is no gift. You have taxable wages in such a case.

Your client does run some risk on several grounds. As Taxmandan stated, it is possible that SSA may consider all distributions taken to be attempts to circumvent the earnings limits. It is also possible that SSA may even consider your client to be not retired and disallow his RSDI entirely. I have not seen that issue in a few years, but several of my clients had to fill out SSA questionaires which warned of that possibility. They (SSA) can apply different definitions of being retired to business owners than to former W2 employees.

Finally, S corporation losses are not subtracted from W2 earnings to determine earnings for RSDI purposes. The profit/loss from S corporations are considered unearned income.

Thanks for your response. But, it creates other questions. I'm not trying to be difficult, honest. I just want to make sure I have the right answer.

First maybe the "sweat equity" terminology shouldn't have been used, "is the stock really being worked for"? The business hasn't even begun operations. Why can't it be structured as a gift, or incentive to join the business in anticipation of future profits? Second, if the distributive share of S-Corp earnings is "unearned income" (which I understand) why would SS consider it "earned income" when calculating the earnings limitation? And, if SS does consider SS earnings "earned income" for the limitation, why wouldn't a loss be subtracted? I haven't asked about SDI benefits the rules may be different. In this situation, the benefits are regular SS benefits.

[taxmandan]

Thanks for your response. But, it creates other questions. I'm not trying to be difficult, honest. I just want to make sure I have the right answer.

First maybe the "sweat equity" terminology shouldn't have been used, "is the stock really being worked for"? The business hasn't even begun operations. Why can't it be structured as a gift, or incentive to join the business in anticipation of future profits? Second, if the distributive share of S-Corp earnings is "unearned income" (which I understand) why would SS consider it "earned income" when calculating the earnings limitation? And, if SS does consider SS earnings "earned income" for the limitation, why wouldn't a loss be subtracted? I haven't asked about SDI benefits the rules may be different. In this situation, the benefits are regular SS benefits.

Your trying to play semantic games, and that's something the gov't bureaucrats are better at than most of us. For it to be considered a "gift" as you put it, then all work that is done for the business would show a reasonable wage via W-2. If all the hours of labor are compensated with reasonable wages, then perhaps you can characterize the shares given to the person as a "gift." But remember it's not your interpretation that matters, it's the SSA that rules.

As for your question about SSA considers S-Corp earnings in calculating limitations, well that would be a popular way to dodge the limits if they didn't consider it. This is not a new idea and the bureaucrats have already thought of it and it won't fly if they find out.

[Taxref]

SSA does not automatically consider S corp profit to be wages for RSDI purposes. However, your client runs the risk of them looking at his situation and determining he is not retired, or that he is taking distributions rather than wages to avoid the limits. If that happens, the negative consequences mentioned by Taxmandan could occur.

I take it that this S corp will be owned 100% by your client. I am not aware of any state which would allow a corporation to gift stock to a shareholder. In one form or another, stock needs to be paid for.

[Unregistered]

SSA does not automatically consider S corp profit to be wages for RSDI purposes. However, your client runs the risk of them looking at his situation and determining he is not retired, or that he is taking distributions rather than wages to avoid the limits. If that happens, the negative consequences mentioned by Taxmandan could occur.

I take it that this S corp will be owned 100% by your client. I am not aware of any state which would allow a corporation to gift stock to a shareholder. In one form or another, stock needs to be paid for.

First, I'm not attempting to play "semantic games". I'm simply trying to get the right answer No, the client would be a minority shareholder I'm not sure what the percentage of ownership would be "gifted", but it would probably be 10-15% at best. Once again, the liklihood is a loss the first year. Let me re-emphasize this is a "seasonal" business, the amount of wages paid even at the full SS earnings limit for benefits for 2007 (about $13,000) would be more than the average compensation for the season to manage such a business. So, lighten up folks! I'm not trying to suggest tax fraud. Of course, the SS folks might not like the situation but if it doesn't violate SS law or definitions of income I'm not sure what the SS argument would be in the courts. It's probably been tested in the courts since I'm sure this isn't a "novel" strategy. I wonder which court or how such cases results are found?

Thanks for the input, but please...I'm not a "sleaze" looking for a way to "cheat" on taxes or SS benefits for a client. I'd rather not see a client give up his small social security benefits to earn such a small income if there's a better way until he's old enough to avoid the limitations (his current age is 63). He doesn't have the funds to invest in a businesss. The business has already organized as a S-Corp, rather than an LLC or Partnership and he's simply in negotiations whether to join them or not. If anyone has a better suggestion, I'd like to hear it! If it's not do-able, or too risky that's ok too.

[ChEAr$]

S corp income

to shareholders is pro rata based on ownership, therefore, why not let the fellow
invest just enough so that his share of income based on the projected income for
next year is just below the 12,960?
Or has a projection been made yet?

Holiday ChEAr$,
Harlan Lunsford, EA n LA

[Taxref]

Since there are other shareholders, those owners may be able to gift some of their shares to you client. I say may, as many closely held corporations have restrictions on transferring shares. You would need to check the articles of incorporation and other documents to see if this is the case in this instance. As I mentioned before, the corporation would not be able to gift shares directly to the new owner.

As a side note, if your client does join the corporation a new 2553 might be needed.