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A person I know is retired and has no earned income but has plenty of income from social security, etc to live pretty much as he pleases. He wants to make contributions to an IRA, preferably Roth, and plans to file a schedule C for a fictitious business. He will claim $2000 as income, pay the $306 self employment tax and contribute $2000 to the IRA. Does the IRA check on things like this or is the amount so small that it is likely to escape unnoticed? If he continues to do this will the self employment tax eventually increase his social security payout? He's a little strange in other ways too in case you're wondering.

There are at least two problems here:

1. This stategy does not make good financial sense in that creating a business to manufacture $2000 of Schedule C net income will cost your friend approx. $860 ($2000 * 28% for federal tax plus the $300 or so in self-employment tax) per year.

2. The IRS is particularly focused on Schedule C filers (because it is a common area of abuse as well as simple error) & if audited, a "fictious" business would most likely be discovered. If audited & if discovered; all the relevant transactions would be reversed & revised computations for all tax years involved would be performed. Then depending on the results, interest & penalties would be assessed.

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