Broker Check

LLC Confuses Social Security Situation

Howard Hook, CFP®, CPA, quoted in The Star-Ledger's business/finance column, "Biz Brain" on October 23, 2012

Question:  A friend has worked for a doctor for over 20 years and Social Security taxes were always paid by the doctor and my friend. The doctor created an LLC and told my friend that he will split his earnings between his office and the new LLC, with commissions being paid by the LLC with no payment toward Social Security. How can a person lose Social Security payments as part of his earnings after 20 years of employment?

Answer:  We're not sure what you mean by commissions are being paid by the LLC with no payment toward Social Security. No Social Security payment for who?

“If you mean that commissions are to be paid to your friend and no Social Security tax will be withheld from the commission checks, then your friend will be responsible on their income tax return to pay the Social Security tax,” said Howard Hook, a certified financial planner and certified public accountant with EKS Associates in Princeton.

If that's the case, Hook said those earnings would be considered to be part of a self-employed business in the eyes of the IRS. That means your friend would be responsible not only for the Social Security tax on commissions, but for the employer part of the Social Security tax too.

To clarify further, a person cannot lose what has already been contributed on his behalf.

“Employers are required to submit the amount of Social Security tax withheld from employee checks as well as make their employer contribution no less frequently than annually,” he said. “To be sure that this happened in the past, your friend should request a benefits statement from the Social Security administration which shows annual earnings and contributions yearly.”

To give you a little more detail, generally, an employee has half of the Social Security and Medicare tax withheld from their wage and the employer pays the other half, said Joseph Matheson, a certified public accountant with Matheson & Assoc. in Whippany.

“When someone is an independent contractor they pay both halves, or 100 percent of the self-employment tax – the equivalent to Social Security,” he said.

Whether someone is an employee or an independent contractor is a “facts and circumstances” test. The IRS currently uses a multi-factor test to determine the proper classification of a worker, he said. That test is summarized in IRS Publication 15A and revolves around behavioral control, financial control and the type of relationship between the parties.

In order to successfully reclassify a worker or workforce from employee to independent contractor or vice versa, the company must conclude that the underlying relationship has changed and that the change warrants the reclassification, Matheson said.

Past taxes that were paid by your friend are also very important.

“If the doctor did not send in the contributions, then he would be would be in a boatload of trouble,” Matheson said, noting your friend would have to prove his W-2 earnings to the Social Security Administration . describe using W-2s or already-filed tax returns, and then your friend would be credited and authorities would go after the doctor.