The absence of federal marriage equality has a powerful impact on your social security. I briefly touched on this in a previous post, Washington to Legalize Same-Sex Marriage?. What I discussed there was in the context of survivor benefits which is unfortunately only one of the social security issues that “unmarried” couples face.
Let’s start with how you accumulate the benefits in the first place. When you are an employee, your employer withholds social security taxes from your wages at the rate of 6.2%. Additionally, your employer makes a match of this withholding at their own expense. The amounts are reflected on your W2 and from here go toward your social security credits; in other words, this is where your social security benefits come from. These amounts, from wages, are not affected by the income-splitting rules for RDP taxpayers. Even though you will be combining and splitting your W2 wages for income tax purposes, the social security credits are still calculated from your employment records.
This is not the same for self-employed people. When you are self-employed, you report and pay your own social security tax, and since you employ yourself, you also have to pay the match. This means you are paying taxes on your earnings at 12.4% instead of 6.2%, a part of what is collectively known as self-employment tax. The tax is calculated on your return as a percentage of your net self-employment income (net profit). On a married filing joint return, self-employment income is linked to a social security number so that only the earner is credited for the social security. When spouses file separately in community property states, even though the self-employment income is split, the self-employment tax is only imposed upon the earner or owner of the business.
The same is not true for RDPs. The special rule allowing the self-employment income earner to receive full credit for the social security, so as to be comparable to how it works with wages, only applies to spouses. Again, because of semantics, these protections do not extend to RDPs. Many tax preparers, including me, feel that the IRS’s position on this issue is incorrect.
There are consequences to this treatment of self-employment tax. Firstly, if both partners are working, it means that one partner is getting 100% credit for the social security attributable to their own wages and 50% of the social security attributable to their partner’s self-employment income. The self-employed partner is only getting 50% of their self-employment credits and 0% of their partner’s wage credits. For many, this is a problem, but for some it could be a benefit.
If one partner is self-employed and the other is not working at all, this treatment allows the non-working partner to accumulate social security credits. This can be extremely important for some since, unlike spouses, a surviving partner is not eligible to receive the deceased partner’s unused benefits. It basically provides a loophole to funnel social security benefits to a non-working partner.
To me though, this potential benefit does not outweigh the potential drawbacks. As is the case with many problems arising from unequal federal rights, there is an issue of double taxation. Let me explain. There is a wage base for social security tax. This means that once you exceed a certain wage level, the earnings above that level are no longer subject to social security tax. In 2012, that base is $110,100 and it applies to both wages and self-employment income. So, if a single or married person makes $150,000, only the first $110,100 is subject to the social security tax. What if you are an RDP in a community property state with $150,000 in self-employment income? The full $150,000 is taxable.
An example: One partner has $200,000 in self-employment income. The rules require this to be split so that each partner reports, and is taxed on, $100,000. Both partner’s shares are now, in their entirety, subject to social security tax since the reportable amounts are both beneath the wage base. This means that social security tax is imposed on the whole $200,000 resulting in $11,148 more tax than a married or single person would have to pay.
While it’s true that most RDP taxpayers are not bringing home over $110,100 in self-employment income, I find it extremely alarming that this sort of disparity in taxation is built into our current tax system. Of course, there are ways to get around this taxation issue. However, to do so would require consulting a financial or legal professional; just another example of the unnecessary burden the income splitting rules put on RDP taxpayers.