SSR 85-19a: SECTION 211(a)(1) (42 U.S.C. 411(a)(1)) NET EARNINGS FROM SELF-EMPLOYMENT -- EXCLUSION OF RENTAL PROPERTY INCOME -- STATUS OF GUARANTEED PAYMENTS FROM A PARTNERSHIP
20 CFR 404.1065 and 404.1082
- The claimant and his sister were in a partnership which was formed to rent the real properties that they owned. The claimant contended that the "guaranteed payments" he received from the partnership for his services as a bookkeeper were includable in determining his net earnings from self-employment. The evidence of record showed that the claimant and his sister were not real estate dealers and that they did not provide any services which were primarily for the convenience of the persons to whom they rented their properties. Held, the "guaranteed payments" received by the claimant as a member of the partnership were actually rentals from real estate; therefore, under section 211(a)(1) of the Social Security Act, they were not includable in determining his net earnings from self-employment.
The issue before the Appeals Council (AC) was whether the claimant had the required quarters of coverage to be fully insured for old-age insurance benefits (OAIB). This depended upon whether the net earnings from self-employment he reported for the years 1980, 1981, and 1982 constituted creditable self-employment income from a trade or business.
On January 14, 1980, the claimant filed an application for OAIB. Based on his date of birth of May 6, 1914, he needed 25 quarters of coverage to be fully insured. His claim was denied because he had only 15 quarters of coverage. When the claimant filed a second application for OAIB on May 7, 1982, he alleged that he had been self-employed in 1980, 1981, and 1982 and that he had sufficient quarters of coverage to be fully insured.
The Social Security Administration (SSA) investigated the claimant's work activities and found that he and his sister were i a partnership which they had formed to hold property for rental purposes. The claimant and his sister owned several homes that they rented and some land which they leased. The claimant and his sister were not real estate dealers, nor did they provide "personal" services for their tenants. The only services that the claimant provided consisted of repairs and improvements which he made to protect his real estate investments. The claimant also handled the partnership's accounting and bookkeeping for which he received a monthly payment. (This payment was referred to as a "stipend," "salary," or "guaranteed payment.") He received $1,200 in 1980 and $1,800 in both 1981 and 1982. The claimant contended that his "guaranteed payments" for accounting services should be considered self-employment income.
SSA determined that the claimant could not be credited with self-employment income for 1980, 1981, or 1982 because his reported earnings for those years were actually rentals from real estate, which are excluded from coverage under section 211(a)(1) of the Social Security Act (the Act). SSA also determined that the claimant was not an employee of his partnership. SSA considered the work performed by the claimant for the partnership to be that of a "working partner" and his "guaranteed payments" for this work to be his distributive share of the partnership's profits. A partner's distributive share of profits from a trade or business may be considered self-employment income, but such a share could not be considered self-employment income in this case because it consisted solely or rentals from real estate.
An administrative law judge (ALJ) found, however, that the claimant's earnings record could be credited with $1,200 in self-employment income for 1980 and $1,800 in self-employment income for both 1981 and 1982. Therefore, the ALJ concluded that the claimant had 27 quarters of coverage and thus was fully insured for OAIB. The ALJ cited section 707(c) of the Internal Revenue Code to support a conclusion that the claimant could receive self-employment income credit for the "guaranteed payments" from the partnership. The ALJ stated that this section of the Code provides that payments to a partner for services shall be considered as if made to one who is not a member of the partnership for purposes of determining gross income. The ALJ interpreted this to mean that the "guaranteed payments" were made to the claimant as if he were employed as an accountant for the partnership.
Section 202(a) of the Act provides, as pertinent here, for the payment of OAIB to an individual who is a fully insured individual (as defined in section 214(a)), has attained age 62, and has filed application for such benefits.
Section 214(a)(1) of the Act provides, as pertinent here, that the term "fully insured individual" means any individual who had not less than one quarter of coverage (whenever acquired) for each calendar year elapsing after 1950 and before the year in which he or she attained age 62.
Section 213(a)(2)(A)(i) of the Act provides, as pertinent here, that the term "quarter of coverage" means, for calendar years before 1978, a calendar quarter in which an individual has been paid $50 or more in wages or has been credited with $100 or more in self-employment income.
Section 213(a)(2)(A)(ii) of the Act provides, as pertinent here, that the term "quarter of coverage" means, for calendar years after 1977, each portion of the total of the wages paid and the self-employment income credited to an individual in a calendar year which equals the amount required for a quarter of coverage in that calendar year (as determined under subsection (d)). (The amounts required for a quarter of coverage were $290 in 1980, $310 in 1981, and $340 in 1982.)
Section 211(b)(2) of the Act, as pertinent here, provides that the term "self-employment income" means the net earnings from self-employment derived by an individual during any taxable year beginning after 1950, except that such term shall not include the net earnings from self-employment if such net earnings for the taxable year are less than $400.
Section 211(a) of the Act provides, in pertinent part, that "The term 'net earnings from self employment' means the gross income, as computed under chapter 1 of the Internal Revenue Code, derived by an individual from any trade or business carried on by such individual, less the deductions allowed under such chapter which are attributable to such trade or business, plus his distributive share (whether or not distributed) of the ordinary net income or loss, as computed under section 183 of such code, from any trade or business carried on by a partnership of which he is a member; except that in computing such gross income and deductions and such distributive share of partnership ordinary income or loss -- (1) There shall be excluded rentals from real estate and from personal property leased with the real estate (including such rentals paid in crop shares), together with the deductions attributable thereto, unless such rentals are received in the course of a trade or business as a real estate dealer. . . ."
Section 404.1065 of Regulations No. 4 provides, in pertinent part, that "For an individual to have self-employment coverage under social security, the individual must be engaged in a trade or business and have net earnings from self-employment that can be counted as self-employment income for social security purposes. . . ."
Section 404.1066 of Regulations No. 4 provides, in pertinent part, that "You can carry on a trade or business as an individual or as a member of a partnership. With some exceptions, the term 'trade or business' has the same meaning as it does when used in section 162 of the [Internal Revenue] Code."
Section 404.1080(a) of Regulations No. 4 provides, in pertinent part, that "If you are self-employed, you must first determine the amount of your net earnings from self-employment before figuring the amount of your earnings that count for social security purposes. Some of your earnings may not be included as net earnings from self-employment even though they are taxable for income tax purposes. . . ."
Section 404.1081(f) of Regulations No. 4 provides, in pertinent part, that "A partnership for social security purposes is one that is recognized as a partnership for income tax purposes. . . ."
Section 404.1082 of Regulations No. 4 provides, in pertinent part, that "(a) In general. Your rentals from real estate and from personal property leased with the real estate . . . and the deductions attributable to the rentals are excluded in figuring your net earnings from self-employment, unless you receive the rentals in the course of a trade or business as a real estate dealer. . . .
(b) Real estate dealers. (1) You are a real estate dealer if you
are engaged in the business of selling real estate to customers for
profit. (2) If you merely hold real estate for investment or speculation
and receive rental income from it, you are not considered a real estate
dealer. (3) . . . The rental income from real estate you hold for
investment or speculation and the deductions attributable to it are not
counted in figuring your net earnings from self-employment.
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- (d) Rental income from living quarters. (1) No services provided for occupants. Payments you receive for renting living quarters in a private residence, duplex, or multiple-housing unit are generally rental income from real estate. Except in the case of real estate dealers, these payments are excluded in determining net earnings from self-employment, even if the payments are in part attributable to personal property furnished under the lease.
- (2) Services provided for occupants. (i) Payments you receive for renting living quarters where services are also provided to the occupant, as in hotels, boarding houses, or apartment houses furnishing hotel services, or in tourist camps or tourist homes, are included in determining your net earnings from self-employment. . . . (ii) Generally, we consider services to be provided to the occupant if they are primarily for the occupant's convenience and are other than those usually provided in connection with the rental of rooms. . . . We consider the supplying of maid service to be a service provided to the occupant. However, we do not consider the furnishing of heat and light, the cleaning of public entrances, exits, stairways, and lobbies and the collection of trash, as services provided to the occupant. . . .
- (e) Treatment of business income which includes rentals from real estate. If an individual or a partnership is engaged in a trade or business other than real estate, and part of the income is rentals from real estate, only that part of the income which is not rentals and the expenses attributable to that portion are included in determining net earnings from self-employment."
Section 404.1007(a) of Regulations No. 4 provides that "The common-law rules on employer-employee status are the basic test for determining whether you and the person or firm you work for have the relationship of employee and employer. . . . In general, you are a common-law employee if the person you work for may tell you what to do and how, when, and where to do it. . . ."
In its consideration of this case, the AC found that section 707(c) of the Internal Revenue Code merely provided the methodology by which the partnership computed its income when guaranteed payments were made. It authorized the partnership to deduct the guaranteed payments from gross income as a business expense before determining the net income of the partnership. It did not change the claimant's status as a bona fide working member of a partnership to that of an employee or independent contractor, not did it change the income derived by the partnership from rentals from real estate, which cannot be used in determining "net earnings from self-employment," to income that can be used in determining "net earnings from self-employment."
Section 210(j)(2) of the Act defined the term "employee" as any individual who, under the usual common-law rules applicable in determining an employer-employee relationship, has the status of an employee. These common-law rules, as explained in § 404.1007 of Regulations No. 4, stress the right of the "employer" to exercise control over the individual alleged to be an employee with respect to the manner in which services are performed. In this case, the claimant performed services in the normal course of the partnership. Viewed in the light of the test required by the Act to establish an employment relationship, the evidence of record did not establish that the claimant was subject to control, or even to a "right" of control, which would make him an employee of the other partner. Furthermore, Internal Revenue ruling 69-184 provides that bona fide members of a partnership are not employees of the partnership within the meaning of the Federal Insurance Contributions Act. Therefore, the claimant's "guaranteed payments" were not wages that were derived as an employee in an employment relationship with the partnership.
The AC did not believe that the claimant was an independent contractor because he would, in effect, have been contracting with himself to perform accounting services for the rental property of which he was co-owner. To be considered a bona fide independent contractor, an individual must hold himself or herself out to and provide services for others. (Braaksma v. Celebrezze, 246 F.Supp. 767 (S.D. Cal. 1965); Folsom v. Poteet, 235 F.2d 937 (9th Cir. 1956). In this case, however, the claimant merely provided services in the normal course of the business carried on by the partnership of which he was a member. Consequently, the AC did not believe that this constituted holding oneself out to others as being available to perform services.
The primary "business" of the partnership was renting homes and leasing land under rental and lease agreements intended to create the usual landlord-tenant relationship. Under § 404.1082 of Regulations No. 4, payments received for renting living quarters or personal property are generally considered rental income from real estate which is excluded when determining an individual's net earnings from self-employment. If an individual rents living quarters or personal property and services (such as maid or linen service) are also provided to the occupant (as in hotels or boarding houses), the payments received are included in determining net earnings from self-employment. The "services" provided must be for the occupant's personal convenience and may not be the kind that are ordinarily provided in connection with the rental of living quarters or land.
The services allegedly performed by the claimant included writing leases, entering into contracts for road repairs, cutting timber and clearing away underbrush on the land, cleaning springs, repairing water lines and bridges, painting and cleaning houses, bookkeeping, and paying for a caretaker and for utilities and insurance. None of the "services," however, was considered to be personal services for the tenants as contemplated in the regulations. These services merely insured the maintenance of the homes and property to protect the claimant's capital investment. He did not allege providing maid services or any other hotel-type services for the convenience of his tenants. Therefore, all of the income derived by the partnership was considered rentals from real estate.
Although the additional share of the partnership's net profit received by the claimant in recognition of his extra services was "guaranteed," the source of the payments was still rentals from real estate. That the claimant was more active than his partner in conducting the rental activities did not change the nature of the activity in which the partnership was engaged or alter the circumstances under which he performed services for the partnership. Therefore, the AC was of the opinion that the claimant's income from the partnership that he had with his sister, including the payments he received for serving as general manager and accountant, constituted rentals from real estate which may not be included in computing net earnings from self-employment under section 211(a)(1) of the Act. Without the inclusion of the alleged self-employment income for the years 1980, 1981, and 1982, the claimant had only 15 of the 25 quarters of coverage he required to be fully insured. Therefore, he was not entitled to OAIB.