Subject to SE Tax?

[WhiteOleander]

Client had a Life Estate on a fram/ranch. His mother originally owned the property. When she passed away, he received the Life Estate and the property would go to clients son (grandson to deceased) upon clients death.

So, client has reported income on a 4835 throughout the years. He did rent out the farm but did also materially participate. So, it was subject to the SE tax.

He has now gifted his Life Estate to his son. (son would have received the farm at client's death.) Client was ready to stop farming. Son pays client $20,000/yr. But client does not martierially participate any longer. Son does not want to call it a gift because he wants to deduct it and not pay taxes. The money is reported on 1099 Misc box 7. We asked the CPA preparing the return for the farm if they would re-issue the 1099 and show payment in box 3 "Other Income". We do not believe the income is subject to SE tax. CPA said no. It is subject to SE tax.

We are thinking we can report the $20,000 on 4835 and show client as not Materially Participating. Client does agree he should pay tax on the money. But, not SE tax.

Anyone have any experience with this type of scenario?

Input appreciated.

[Bees Knees]

TTB has a good discussion on this on page 7-9. Simply put, if the farm landlord does not materially participate, as defined on page 7-9, it goes on Form 4835 and is not subject to SE tax.

You know as well as I that a 1099-MISC does not determine whether something is subject to SE tax. It is facts and circumstances that determine it. If you feel your client is not subject to SE tax under the rules, then zero out the SE earnings and report the income on Form 4835.

[Black Bart]

Details please.

...zero out the SE earnings...

Where? F? Any particular wording? Thanks.

[WhiteOleander]

Thanks Bees Knees. I just wanted to make sure I wasn't overlooking a glaring conflict with my decision.

Black Bart. I have zero'd out the SE earnings before on a Sch C. I report the earnings as gross income. Then I report the same figure as "other expenses" and call it "Mis-characterized income."

This reports the income for the computer matching program. But does not generate the SE tax.

Then I report the income where I believe it should be reported. Sometimes I attach an explanation. Sometimes just wait to see if IRS wants more info.

[Black Bart]

Thanks W.O.,

Black Bart. I have zero'd out the SE earnings before on a Sch C. I report the earnings as gross income. Then I report the same figure as "other expenses" and call it "Mis-characterized income."

This reports the income for the computer matching program. But does not generate the SE tax.

Then I report the income where I believe it should be reported. Sometimes I attach an explanation. Sometimes just wait to see if IRS wants more info.

I've got one guy who gets somebody else's interest and I always make a "nominee-middleman" 1099-INT to do away with it, but almost every year he gets a CP-something notice saying "interest was omitted" and I have to send in a copy of the 1099/1096 and explain. They (IRS) always abate it, but it's just a pain in the neck to have to deal with year after year, so I think I'll try your way next season and I'm kinda thinkin' that''ll cure it.

You know, the longer I deal with this stuff, the more I think that no human being (other than data entry personnel) actually even reads the paper we send in unless a computer kicks it out of the pipeline. I've seen several returns with just absurd entries that any rational/knowledgeable person would flag for a second look and they sail right on through the system without a hitch.

Thanks for your help. As a token of appreciation, I promise not to send you (don't know if I'm supposed to mention the "B" word here or not) any more junk cases this year and will direct them down the street to Petco -- strike that; I mean Jackson-Hewitt (sorry about that Paul, but those guys have been givin' me a fit the last couple of years with their "last paycheck stub" loan program and I'm still poutin' about it).

P.S. I agree with Bees (that's always a safe bet) and you -- no SE due.

[jainen]

what the son says it is

>>I just wanted to make sure I wasn't overlooking a glaring conflict with my decision.<<

Well, I say you ARE overlooking a glaring conflict. You have stated various arguments (some of them mere desires) about what the payments are not. How about finding out what they ARE?

Obviously Form 4835 is completely inappropriate because the taxpayer is not a property owner collecting rents. He doesn't have any legal interest in the farm at all.

I'll tell you what this is. It's just what the son says it is. He is skimming a big chunk of profits off the farm to avoid SE tax, and -- just a wild guess, the old man is in a lower tax bracket?

[WhiteOleander]

Jainen,
Thanks. I can always depend on you to cut to the chase. That is a big problem with the whole scheme.

Have to really counsel with the client.

What to do. What to do.

And by the way BB, I'm still trying to find one of those monkeys. I'll let you know if I do.

[George Boutwell]

Obviously Form 4835 is completely inappropriate because the taxpayer is not a property owner collecting rents. He doesn't have any legal interest in the farm at all.

Exactly.

What it is, is a sale of a life estate in real property. If the father expects to get $20,000 a year for life, there are ways to figure the value of a private annuity. I had one of these about 20 years ago, involving an uncle selling a rental property (fee simple, not life estate) to a nephew. I had to look it up then, and I would have to look it up now. In that case, the buyer had something to depreciate. In this case, the son probably doesn't.

$20,000 has the flavor of two $10,000 annual gifts, perhaps from the son and his wife, who didn't get the news that the exclusion has increased to $12,000 each.

[cpadan]

Would father prefer son not to pay him $20,000 per yerar? Unless he legally gifted to son, then sounds to me like father rents to son his LIfe Estate for $20,000 a year. Rental income on Schedule E.
Dan