IRS Rules Post-Retirement Payments Are Subject to Self-Employment Tax

Posted on Tue, Feb 21, 2017 ©2021 Drucker & Scaccetti

By: Tiffany Diaz, CPA

 

In a perfect world, retirees would receive post-retirement payments from former employers tax-free. However, a recent IRS letter ruling puts a damper on that notion. In this short blog, we give an overview of the details and the only exception to the rule regarding post-retirement payments.

 

The IRS letter ruling 2016-0081 determined a retiree’s payments from a former employer were subject to the self-employment tax, since the payments were earned as a result of the retiree’s 34 years of service to the company and were not being treated as wages subject to payroll taxes. The IRS used Section 1402(b) of the Internal Revenue Code ("the Code") to analyze the situation. The Code states any payments received are subject to the self-employment tax (i.e., FICA/Medicare taxes) if the payments were earned performing activities for any trade or business.

 

This IRS letter ruling does not address distributions from IRAs and qualified retirement plans. These types of distributions are not directly related to the work performed while an active employee of a company and, hence, not subject to the self-employment tax. You can read more about the taxation of Required Minimum Distributions from IRAs and qualified retirement plans here.   

 

The IRS referenced two cases to support the determination: Newberry v. Commissioner, 76 T.C.441 (1981) and Peterson v. Commissioner, 827 F.3d 968 (11th Cir. 2016). In both cases, the courts determined that any income, whether earned in the past, present, or future, is subject to self-employment tax, if there is a connection between the income received and the trade or business that is, or was, carried on by the taxpayer.  This means the taxpayer produced/worked for this income by performing an activity, so regardless of when the income is received—even in retirement—it is now subject to either payroll tax withholding or self-employment tax.

 

There is an exception to this treatment found in Code Section 1402(k). Certain payments received by former insurance company salespeople are not subject self-employment tax if specific requirements are met.

 

This ruling should bring some clarity to an issue that has confused many retirees, particularly former partners in professional services such as law firms.  If you are receiving multiple sources of post-retirement income and are unsure of which, if any, are subject to self-employment tax, call on us.  We’d be happy to help.

 

Topics: FICA, law firms, self employment, Payment, Form 1099, Tax, IRS, Medicare, IRA, Required Minimum Distributions, Distributions, Letter ruling, post-retirement, professional services

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