Chapter 6DSelf-Employment Taxes, Deductions

Howard Godfrey, Ph.D., CPAProfessor of Accounting ©Howard Godfrey-2015

Self-employment Income

Self-employment Tax

Self-employ. Health Ins.

Deductions for Self-Employed TaxpayersBIG PICTURE: To provide self-employed taxpayers equity with the tax treatment of employees, they are allowed to deduct:

• The cost of health insurance premiums paid for themselves• 50% of the amount of self-

employment tax paid

Self-Employment Taxes• Self-employed individuals must pay both

the employer’s and the employee’s share of FICA taxes for a combined rate of 15.3%–12.4 % (6.2% x 2) for Social Security on income

up to $118,500 in 2015–2.9% (1.45% x 2) for Medicare – no income limit

• Deduction for employer portion iis simulated by multiplying net income from by 92.35% (100% - 7.65%) before calculating SE tax

Self-Employment Taxes• Tax computed on Schedule SE• Self-employed individuals are also

allowed a deduction for AGI for the employer’s half of self-employment taxes–Calculated by multiplying net income from

self-employment by 92.35% (100% - 7.65%) before calculating SE tax

• There is no deduction for the employee’s half of the taxes

John Taxpayer, Ann Taxpayer – Slide # 1John Taxpayer earns $100,000 working as an EMPLOYEE for Bank of America. Take-home pay is $92,350 after FICA withholding of $7,650 (but before income tax withholding). [FICA W/H rate is 7.65%.]Bank of America withholds FICA of $7,650, and sends $15,300 to the IRS. John does not include the employer share ($7,650) in his income. John may not even know about the extra amount sent to the IRS.

John Taxpayer, Ann Taxpayer – Slide # 2The following explanation (for Ann Taxpayer) refers to what would happen if Congress had not provided “relief” for self-employed individuals. Ann earns $100,000 working for Wells Fargo as an INDEPENDENT CONTRACTOR. Ann has the equivalent take-home pay of $84,700, after Self-Employment tax (SE tax) (before considering her income tax). She would have to pay the entire $15,300 for FICA (Actually called SE tax). She would not have an employer to make the payment of the “employer share” ($7,650).

John Taxpayer, Ann Taxpayer – Slide # 3Ann would need to earn amount “about” equal to $100,000, plus about $7,650, in order to be in a situation equivalent to John who makes $100,000.But if Ann earns $107,650, does she pay self-employment tax on the base of $107,650? Does she include this amount in income, to compute income tax on her tax return?Congress provided “relief.” The SE base is equal to net income from self-employment work, multiplied by 92.35%. Essentially, Ann can earn ABOUT $107,650 and be treated fairly, compared to John.

John Taxpayer, Ann Taxpayer – Slide #4Assume Ann earns $107,650, the "deduction of employer share" [92.35%] will give a base for SE tax of $99,414.78, which is close to $100,000. [The computation is a little tricky.]If Ann earns $107,650, she will multiply that amount by 92.35%, to get her SE base of $99,414.78. She will pay 15.3% of the base, which is $15,210.46. Total earnings of $107,650, less the SE tax, gives take-home pay of $92,439.55, after SE tax (before income tax). Ann will have “about” the same take-home as John ($92,350 above).

John Taxpayer, Ann Taxpayer – Slide # 5If a person earns income (other than salary or commissions, etc. from an employer) the person’s income may be classified as self-employment income.Self-employment includes amounts earned in a proprietorship, as well as director fees, a share of partnership income, etc.It does not include dividend income, interest income, and most capital gains.

John Taxpayer, Ann Taxpayer – Slide # 6Bank of WellsAmerica Fargo

Employee Contractor

FICA SE Tax7.65% 7.65%

Take-HomePay SE Tax

7.65%

xxx xxx

$100,000 $100,000

$0

$7,650$92,350

$84,700$7,650

$7,650

$7,650$107,650

$92,350

John Taxpayer, Ann Taxpayer – Slide # 7Salary - Ann 100,000.00$ FICA Withheld 7,650.00 Take-home - ANN 92,350.00

Contract payments 100,000.00$ Extra Earnings 7.65% 7,650.00 AnnNew Gross - John 107,650.00 vs. 100,000$

92.35%S.E. Base - John 99,414.78 S.E Tax Rate 15.3%S.E. Tax - John 15,210.46 Take-home- John 92,350.00$ Before Income Tax

Take-home- Ann 92,439.54$ Before Income Tax

Self-Employment Tax [Carrie]Carrie owns a business that she operates as a sole proprietorship. The business had a net profit of $25,000. This is Carrie’s only earned income.a. How much self-employment tax does she pay?b. How much can she deduct on her tax return, for her self-employment tax?c. If the business had a net loss of $10,000 (instead of a $25,000 profit), how much in self-employment taxes must Carrie pay?

Self-Employment Tax for Carrie [2]Compute self-employment taxNet profit on Schedule C $25,000Factor for S.E. tax base 92.35%

S.E. Tax RateS.E. Tax Deduct 50% of S.E. tax

Self-Employment Tax for Carrie [2]Compute self-employment taxNet profit on Schedule C $25,000Factor for S.E. tax base 92.35%

23,088S.E. Tax Rate 15.30%S.E. Tax 3,532Deduct 50% of S.E. tax 1,766$ No S.E. Tax for Loss Year.

Self-Employment Tax [George]George has net income from self-employment of $50,000 in 2015.He has a salary of $100,000.What is his self-employment tax?What amount may he deduct?

Net profit on Schedule C $50,000

Factor for S.E. tax base 92.35%

Base for S.E. Tax $46,175

Limit for S.E. Tax $118,500

Salary 100,000

Limit 15.30%

Excess 2.90%

Totals

What amount may he deduct? [50%.]

Self-employment tax for George [2015]

Net profit on Schedule C $50,000

Factor for S.E. tax base 92.35%

Base for S.E. Tax 46,175$

Limit for S.E. Tax $118,000

Salary 100,000

Limit $18,000 15.30% $2,754.00

Excess 28,175 2.90% 817.08

Totals $46,175 $3,571.08

What amount may he deduct? [50%.] $1,785.54

Self-employment tax for George [2015]

There is a $118,500 limit on earnings subject to the 6.2% retirement tax. This limit applies to: (1) total of earnings from wages, etc., and (2) earnings from a self-employment activity.A person with a salary of $118,000 will have 15.3% of that salary paid to the IRS (7.65% withholding and 7.65% match by the employer).That means that no more than $500 of income from self-employment will be subject to the 6.2% part of the 7.65% rate.All salary & self-employment income is subject to the 1.45% employee part and 1.45% match.

$200,000 and up

Rate of1.45% on

earnings above$118,500

Medicare only$118,500

Rate of Total rate of 6.20% 7.65%

on onearnings earnings

up to up to$118,500 $118,500

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Tax Rates for Social Security and Medicare Tax

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