Can she legally do that? Of course not, and I think you know that. If she pays someone to do work for her company, that person is either an employee or an independent contractor. As an independent contractor, you are required to keep accurate business records of your income and expenses and file a tax return, even if you don't get tax paperwork from the client.
The $400 limit to report self-employment income only applies if that is your only income. If you file a tax return for any reason (a joint return with your spouse or an MFS return), you must report all your income, even $1 of bank interest or $399 of self-employment income. (If you have no other job and the two you decide to file married filing separately so your income is less than $400 and you don't have to file, be aware that many deductions and credits are reduced or disallowed for MFS, and if your spouse itemizes deductions on schedule A, you must file a return if your income is $5 or more.)
Would you get caught if she pays you "under the table" and deducts it as an expense without you reporting income? Probably not, since most taxpayers are never audited. But that doesn't make it legal.
