SE Earnings Reduced Social Security Benefits

M owned and operated real estate development company C, an S corporation. He entered into a consulting agreement with C, under which he was to receive $100,000 on signing the agreement and $5,000 per month through 2000. M did not receive payment under the contract, but in 1997 reported $264,398 income on Schedule C, Profit or Loss From Business, pursuant to a Form 1099 issued to him by C. C, an accrual-method taxpayer, deducted $264,398 in consulting fees paid to M in 1997 to minimize the tax on $283,000 of earned but uncollected 1997 income.

C did not actually pay M the $264,398, but issued him a promise to pay it on selling some lots in the future. M borrowed more than $20,000 to pay the resulting 1997 income and self-employment (SE) taxes. He admitted making the conscious decision to handle the consulting fees in this manner.

Social Security Reduction

M was 62 and receiving Social Security retirement benefits in 1997. The issue is whether the SE earnings reported on Ms 1997 Form 1040, for which he received no cash in 1997, are earnings in determining whether he had excess earnings that would reduce his Social Security retirement benefits.

In 1999, the Social Security Administration issued M a notice that it had overpaid his benefits in 1997 by nearly $10,000, because the SE earnings reported on his 1997 return reduced his Social Security benefits to zero for that year. M argued that he had prepaid the income taxes on the reported income that he had yet to receive. As a cash-basis taxpayer, he argued that the reported income was not earnings that reduced his Social Security benefits. The district court granted summary judgment to the IRS; M appealed.

Analysis

The Social Security Act (SSA) permits a retired person to engage in some work activity without losing retirement benefits; see 42 USC Section 403(b) and (f). Once the individuals earnings exceed the applicable exempt amount ($13,500 in 1997), the benefits are reduced $1 for each $3 earned above the exempt amount; see Section 403(b) and (f); and 20 CFR Sections 404.415(a) and 404.430. The Social Security regulations define earnings as an individuals earnings for a tax year, including both wages and net SE earnings; see 20 CFR Section 404.429(a). Further, net SE earnings are includible as earnings in the year they are reportable for Federal income tax purposes; see 20 CFR Sections 404.428(b) and 404.1080(d)(3). The SSA and the Code are to be construed similarly to determine the earnings for which an individual will receive credit for benefit purposes and on what earnings an individual must pay Social Security tax; see 20 CFR Section 404.1001(c). Thus, to determine whether Ms Form 1099 income was properly included as excess earnings for Social Security purposes in 1997, it must be determined whether such income was reportable for income tax purposes.

M argues that because he is a cash- basis taxpayer, the Form 1099 income was not reportable until he received it, even though he actually reported it on his 1997 return. He relies on 20 CFR Section 404.1080(c), which states that gross income from a trade or business includes gross income received (under the cash-basis method) or accrued (under the accrual method) from the trade or business in the tax year. However, many interrelated provisions are involved. For example, Sec. 6041A(a) requires a business that pays remuneration to any person for services performed during the calendar year to file an information return (Form 1099), reporting the recipients name and address and the payment amount. Under Sec. 267(a)(2), if the business is related to the person performing the services, it cannot deduct the payment on its tax return as a business expense, unless the recipient includes the payment as income on his or her individual return in the same year.

Receipt of a Form 1099 does not conclusively establish whether the recipient has reportable income. If the recipient has a reasonable dispute over the amount reported, Sec. 6201(d) places the burden on the IRS to produce reasonable and probative information before the reported payments are attributed to the recipient.

Applying these provisions, it is clear that M received reportable income in 1997. C issued a Form 1099 to M reporting payments of $264,398. M did not invoke the Sec. 6201(d) procedures or otherwise dispute the amount reported. Rather, he reported the amount on his cash-basis 1997 Schedule C as SE earnings and paid the corresponding income and SE taxes. C deducted the reported payment as a consulting fee on its S corporation return, greatly reducing the income subject to tax that passed through to shareholders. M made a conscious decision to treat the income as reportable (and so reported it), and now must accept all of the resulting consequences; see Bean, 268 F3d 553, 557 (8th Cir. 2001).

Conclusion

Because the Form 1099 income was reportable for income tax purposes, it was also earnings under the Social Security regulations and properly included in calculating Ms excess earnings for Social Security purposes under 20 CFR 404.428(b) and 404.1080(d)(3). M cannot have it both ways; either the Form 1099 income was reportable for both income tax and Social Security purposes, or it was not. Having reported the income on his tax return, the income must be recognized as excess earnings for Social Security purposes. The judgment is affirmed.

Max M. Mason, 8th Cir., 5/5/05

Reflections: In addition to preventing reduction of benefits, postponing receipt of earned income can lower provisional income and, thus, the taxable amount of benefits. If possible, retirees who have not reached full retirement age should also consider accelerating receipt of earned income to the year before receiving Social Security benefits or waiting to receive the Social Security benefits. For a detailed discussion, see Fink, Planning Liquidation of Investments in Retirement, 34 The Tax Adviser 164 (March 2004).