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This is question for a tax/pension type person. A client had…

This is question for a...
This is question for a tax/pension type person. A client had her sister working for her with a verbal agreement to take care of her during retirement, kind of an unofficial pension plan. in 2015 the client paid sister 45000 dollars even though she did not work for him. This was a continuation of her w=2 income. Client is well off with income in million dollar range. Sister got bllled for Social Security and Medicare tax out of her w-2 income. in 2016 client gave her 1000 per month as a gift and no w2 income. The 2015 payment was just done as a continuing w-2 of what she had previously been paid. Client is thinking he should go back and amend 2015 w2 to a 1099R so sister does not have to pay social security and medicare, and should continue to pay her as a tax free gift of $1000 per month. I believe this allows sister to live in reasonable comfort now that her social security has kicked in. Now, the client wants to go back and amend the w2 for 2015 and cancel it and make it a 1099-R or some such. Can this legitimately be done? Can he deduct 1099 r as business expense?or some sort of 1099 as business expense in this circumstance?
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Answered in 7 minutes by:
12/6/2017
Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 31,201
Experience: Taxes, Immigration, Labor Relations
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First of all - using form 1099R and report retirement income is not appropriate.

But regardless - we need to classify these payments properly before reporting.

If that is a compensation n for services - current or future - it will be taxable income - and generally reported on W2 - and will be subject to social security and Medicare taxes.

If that is a gift - no reporting required.

Still we need to consider that the gift is the transfer of property by one individual to another while receiving nothing, or less than full value, in return. So - if that is a payment without any considerations - it is a gift.

Payments to the sister as a gift or as a compensation for providing personal services may NOT be deducted as business expense.

Sorry if you expected differently.

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Customer reply replied 2 months ago
OK. So if a client loosley promise an employee a retirement income, in exchange for years of service, he can:1) Report is as W2 income or...2) treat it as a gift.Is there no other legit option?

The "promise" may ONLY affect relations and obligations between these two persons.

But for tax purposes we need to classify such payment.

That is not a matter of choice - but a matter of proper classification

IF that is a compensation for services - it will be taxable income.

If this is a gift without any considerations - that is a gift.

Based on your information - there are considerations - and as such payments are compensation for services.

Next step we need to classify the service provider as either an employee or as a self-employed contractor

But because the nature of services are personal - they should not be treated as deductible business expenses.

.

Other options to supplement income for the relative might be to set a trust and name that relative as a beneficiary.

We may state in trust's documents that distributions from that trust starts at some time in future - for instance when the sister reach certain age or when the settler dies.

It is also possible to name the sister as a beneficiary of the estate - which she will inherit after the principal dies.

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I appreciate if you take a moment to rate the answer.

Experts are ONLY credited when answers are rated positively.

If you still have any doubts, need clarification - please be sure to ask.

I am here to help you with all Social Security / Tax related issues.

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Customer reply replied 2 months ago
Dear Lev,
This is confusing to me. Can you please give me a practical answer to the question.My client promised a relative he would pay her after she could no longer work. The closest I could classify it is as a verbal promise to provide support or pension. It was much too loose to be a pension plan, nor did my client provide a plan to other employees.
Customer reply replied 2 months ago
The nature of the service was not personal. This is what I found confusing. The worker was paid w2 income while working and worked for my client delivering good and service and my client received payment for these goods and services. Definitely an employee. Now, client did not set up a pension plan. She paid her sister the final year after she stopped working (probably not well enough to work) her pay. This is, I believe, fine. She kept paying an employee because of a verbal promise. She would like to go back and reclassify as 1099-R. I believe there is no way she can do this, right??She could go back and reclassify as a gift, but this would mean she owed more tax as her profit would go up. Now, she is not actually my client. She asked me to call up and help her out on this and is a potential client. But I really see nothing I can do to help her here. I was not involved in prior years continued w2.After the first year she paid on salary, she ended that and has been gifting about 1 g per month. Now the client would probably like to go back and pay sister on 1099-R and keep the business expense and lower sisters SS amount due. I believe this is not possible as not a legitimate pension plan offered to all her employees. Nor can she deduct the 1g per month as a business expense as she did not offer it to other employess. So she probably needs to forget about amending the W2 and carry on with the montly gifts.Am I missing something here? I do not see my potential client is going to get into trouble for paying a year of w2 and then gifting her sister 1g per month. Nor do I see a better solution.Am I missing something here, or do you agree?

That definitely is not a pension paid to a former employee because there is no pension fund formally set.

So the IRS would NOT accept 1099R reporting - and I agree that would not be correct approach.

.

If that is a payment (based on prior promise) to a former EMPLOYEE - regardless of the relation - that is compensation for services - and re-portable on W2.

Whether the employer may deduct such payment as business expenses - we need to verify that compensation is reasonable. If that is a reasonable compensation - it may be deducted as business expense.

.

However - if that was a promise to a RELATIVE - regardless that relative was also an employee - and I believe that is teh case - these payments are mere gifts - and should be treated as such.

Gifts made to the relative may NOT be deducted as business expenses.

.

So the main issue - to have a proper classification.

Thus based on information your provided - these are gifts to a RELATIVE - not taxable for the recipient and not deductible as business expenses.

Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 31,201
Experience: Taxes, Immigration, Labor Relations
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