Q: After retiring, my wife received deferred compensation for five years from an insurance company with whom her employer had arranged an annuity. The last payment was supposed to have been made in February 1984. When the payments continued, I phoned the insurance company and was told that a balance remained in the account. The checks stopped coming in December. But I recently received a letter from the company saying it had overpaid my wife by $1,091 and asking for repayment. Since the extra amount was included (and taxed) as income for 1984, how do I now reclaim the tax paid?
A: There is a pretty easy remedy. On your 1985 tax return, find the line marked "other income" on the first page of Form 1040. For 1984, this was line 22, but I don't know where you'll find it on the 1985 form, especially if some kind of tax legislation is enacted this year.
On that line, you should write "1984 income repaid in 1985" and you should enter the amount of $1,091 in the right-hand column in brackets. Then when you add all the figures in that column to arrive at total income, remember to subtract the figure in brackets instead of adding it. That will reduce your 1985 tax to compensate for the overpayment in 1984. (Don't forget to make the same adjustment on your state tax return.)
This is the correct method only if the amount repaid is $3,000 or less. You should recognize that tax indexing this year and the possibility of year-to-year differences in income and deductions may distort the recovery slightly.
If the amount repaid is more than $3,000, there is a somewhat more complicated method of calculating the amount of tax to be recouped, involving a comparison between the tax saved by the method described and the tax that was incorrectly paid in 1984. See IRS Publication 17.
Q: I'm looking for information on deferred income. Apparently, income tax is deferred until the money is received. But how about Social Security tax? If, as a self-employed person, I defer income in excess of the maximum subject to self-employment Social Security tax, will I be required to pay Social Security tax on the deferred income later when it is received?
A: FICA tax is due on deferred compensation either for the year the services were performed or the year in which there is no longer any substantial risk of forfeiture of the payments, whichever comes later. Barring some special language in your contracts, the rules really mean that your deferred compensation is subject to FICA tax in the year earned, rather than in the year paid.
Since you already are earning the maximum subject to FICA tax, in effect the deferred compensation escapes that levy altogether. The compensation is above the FICA ceiling in the year earned, and is not subject to the tax in the year received.
Be sure that the deferred compensation arrangement is covered by a formal agreement with the payer that clearly defines the payment plan. Otherwise, the IRS might conclude that the compensation is really available to you on request; in turn, this might create an income tax liability in the year the services are performed, under the theory of constructive receipt.
Q: My wife and I both work and both have IRAs. If she gives up her job to go back to school for two years, can I contribute the legal limit of $2,250 to our present IRAs or must we open a third, spousal IRA for her during that period?
A: No need to open a third account -- the funds from her own contributions while employed and from your spousal contributions while she's in school may be commingled in the same account.
I'm sure you understand that of the $2,250 limit, no more than $2,000 may be deposited in either account in any one year. And you should know that the employment determination is made on a calendar year basis; that is, if she attends school until September, then returns to work during the last quarter, she is eligible for her own IRA contributions based on earnings during that quarter, but you may not make a spousal contribution at all for that year.