Self-Employed Pay Some Tax Twice
QUESTION--As I understand the justification behind the new rule concerning partial taxation of Social Security, taxing as much as half of some Social Security benefits is considered appropriate because half of all Social Security payments were paid in by employers rather than by employees. Under that theory, half of Social Security benefits received by retired persons would be regarded as income on which the recipient never paid tax. Is my understanding correct? And if it is, are the rules the same for the hundreds and thousands of Social Security recipients who were self-employed before retirement and therefore had no employer to pay half of the Social Security for them? If so, then isn’t this double taxation?--Y.F.
ANSWER--You are right on all counts. Social Security recipients who were self-employed before retirement are not immune to these new tax rules that took effect last year. The formula used to determine who must pay taxes on their Social Security benefits, and how much they must pay, is standard for all recipients, regardless of whether they worked for someone else or for themselves.
The formula is this: Add half of your Social Security benefits for the year to the sum of your adjusted gross income plus interest income from tax-exempt obligations. From that figure, subtract $32,000 if you are married and filing a joint return (or $25,000 if you are single). If the result is a negative figure, you won’t be taxed on your benefits. Otherwise, divide the excess by two. You will pay taxes on that number or on half of your Social Security benefits, whichever is smaller.
For self-employed persons who contributed 100% of their Social Security income and who therefore have already paid taxes on the full amount once, this is indeed a form of double taxation. That is one of many reasons that the law has been so bitterly opposed by Social Security recipients and special-interest groups representing retired persons. Q--I was married to a man who, in addition to his regular wages, was conducting business on the side that he didn’t think I knew about. I found out when I discovered some bank statements of accounts opened while we were married about which I knew nothing. During our divorce proceedings, he lied under oath about the amount of his income, which drastically affected the amount of financial support I was granted. So, I wrote the IRS, requesting a copy of my husband’s tax return so I could prove my allegations. They denied my request on grounds that the law prohibits the IRS from releasing information on a taxpayer without his or her signed consent. I was under the impression that a wife was legally entitled to see the tax return of her husband. What are the rights of a spouse as far as the IRS is concerned?--V.O.
A--Had you filed a joint tax return with your husband, you would have been entitled to a copy of the return, of course. Otherwise, your relationship to him is meaningless in terms of seeing his tax records. You aren’t entitled to them without his permission.
This rule has caused enormous problems for spouses whose husbands or wives keep them in the dark about the family finances.
That is particularly true in community property states such as California, where some taxpayers have taken advantage of state laws requiring income to be split 50-50 in order to reduce their own tax liabilities and increase their spouse’s without the spouse’s knowledge. Unraveling the ploy is complicated by the fact that the spouse isn’t entitled to see his or her mate’s tax return without prior permission.
This ploy is usually put to work by someone whose marriage is on the rocks and who earns substantially more than his or her spouse. This taxpayer suggests to the unsuspecting spouse that the two file separate returns. He or she then reports just half of the couple’s total income and expenses instead of the actual amounts, citing state community property laws. Responsibility for the other half is left to the unsuspecting spouse who hasn’t received a portion of the mate’s paycheck and whose actual income is substantially less.
To protect unsuspecting spouses in such cases, there has long been on the books a law knowns as the innocent-spouse provision. Under this law, spouses who fall victim to such a ploy have been protected from paying penalties on taxes they didn’t know they owed. They were, however, liable for the due taxes.
The Tax Reform of 1984 took this protection a step further. Beginning this year, a husband or wife is prohibited from using community property laws to split the family income in half for income tax purposes without first notifying his or her spouse. If, for whatever reason, the spouse can’t be notified in advance, the splitting tactic won’t be allowed by the IRS.
The taxpayer will have to prove to the IRS that the spouse has received written notification. Because regulations have not yet been written on this, no notification form is currently available.
Even in those cases where the spouse consents to the arrangement only to find out later that she didn’t realize to what she was consenting, there is some protection. The new law states that a so-called innocent spouse is not liable for tax attributable to community property laws if she had no knowledge of the funds on which she is being taxed or if the IRS or the courts determine that it would be inequitable for her to be required to pay taxes on the income in question. Debra Whitefield cannot answer mail individually but will respond in this column to financial questions of general interest. Do not telephone. Write to Money Talk, Business section, The Times, Times Mirror Square, Los Angeles 90053.
