SE Tax, Credits, and Payments

SELF EMPLOYMENT EMPLOYMENT (SE) TAX: (SE) TAX: (MTG Paragraphs ) WHAT it is: both the employer and employee portion of the social security and Medicare taxes. WHERE it is reported WHERE it is reported: SE tax is calculated on Schedule SE and reflected on Form 1040, page 2. WHO pays it WHO pays it: Individuals with self-employment earnings of $400 or more

SE Tax Details: This is a major expense for self-employed individuals (sole proprietors, partners in partnerships). There is an "above-the-line" deduction for one-half of the SE tax. SE tax is computed separately for each spouse.

Calculating the SE Tax (2002): Social Component Medicare Component SE Tax Amount 12.4% on the first $84,900 of net earnings from self-employment. The $84,900 amount is referred to as the “OASDI maximum base." This base increases annually with inflation 2.9% on all net earnings from self-employment (no annual maximum)

Self-Employment Income Self-employment income includes : sole proprietorship total earnings from a sole proprietorship (Schedule C net income) partnership income (2000 Schedule K-1, line 15a). AND

Calculating Net Earnings from SE Self-Employment Income x.9235 Any wages received as an employee Sole Proprietorship earnings plus partnership income Schedule SE (long one), Section B Net Earnings From Self- Employment

Example: Simple Case: Net earnings from self employment < OASDI max base Karen has net income from her sole proprietorship of $40,000. Compute Karen’s SE Tax. ??

Example: More Complex Case: Net earnings from self employment > OASDI max base Sue has net income from her sole proprietorship of $120,000. Compute Sue's SE tax. ??

Deductions vs. Credits Deductions reduce taxable income. To calculate the tax benefit: Deduction Amount x Marginal Tax Rate (which tax bracket the taxpayer is in) Help! I’m Taxable Income! I am a Deduction bird and I will reduce you! Tax Benefit

Credits: Credits reduce tax liability dollar-for-dollar. To calculate the tax benefit: Full Amount of Credit = Tax Benefit IT”S THAT SIMPLE!

Refundable vs. Nonrefundable Credits Nonrefundable credits are limited to … Nonrefundable credits are limited to … Refundable credits can be taken even if … Refundable credits can be taken even if … Income tax before credit The total exceeds income tax before credits

Child Tax Credit (MTG Paragraph 1302) Amount of Credit = $600 for each qualifying child Qualifying child: U.S. citizen/national/resident under 17 as of year end under 17 as of year end who qualifies as the taxpayer’s dependent and who qualifies as the taxpayer’s dependent and is a descendent, stepchild, or foster child is a descendent, stepchild, or foster child

Phase-out of Credit The total credit for all children is reduced by $50 for each $1,000 (or fraction thereof) of AGI over stated amounts that vary with filing status. Find threshold amounts in MTG. This appears to be a bit more tricky than it should be!!!

Example: In 2002, Jay and Jane are married and file a joint return and have AGI of $125,302. Jay and Jane have four children: Roxanne I (17), George (14), Suzy (8), and Joey (5). Compute the 2002 child tax credit. ??

HOPE Scholarship Credit Lifetime Learning Credit Reported on Form 8863 EDUCATION CREDITS (MTG Paragraph 1303)

HOPE Scholarship Credit Taxpayers are allowed up to a $1,500 credit for tuition and fees (not books) for each qualified student. The rate is 100% of the first $1,000 of tuition/fees and 50% of the second $1,000 of tuition/fees. HOPE credit is only available for the first two years of post-secondary education. NOT BOOKS! NOT FOREVER!

Lifetime Learning Credit Taxpayers are allowed a 20% credit against a $5,000 maximum amount of tuition and fees (not books). Credit can be claimed as long the qualifying expenses are paid. No doubling up with the HOPE credit is allowed—can’t take both credits on the same tuition/fees. NOT BOOKS!

Education Credits: The Low Down WHO Applies to education expenses of the taxpayer, spouse, or dependents. (It doesn’t matter who pays the expenses.) BUT… A taxpayer cannot take the credit if he/she is claimed a dependent on his/her parent’s return.

Education Credits: The Low Down Qualified expenses must be reduced by amounts received and excluded from gross income under education-related provisions of the tax law: Excluded Scholarships Education IRAsExcluded Employer Reimbursements

And Finally… The HOPE and Lifetime Learning credits are ratably phased out based on AGI levels HINT: See Form 8863, Part III (AGI) within phase-out range will not be on exam; below/above is fair game.

Example : Kristen is a freshman student at UConn. Her parents claim her as a dependent. Kristen spends $4,000 on tuition, $500 on fees, and $1,000 on books. Compute the amount of the education credit. ?? Who claims the credit? ??

Assume instead that Kristen is a senior accounting major at UConn and that she receives a $500 scholarship. Compute the amount of the education credit. ?? ?? Who claims the credit? ?? ??

Example : Assume that Kristen is a graduate student and is not claimed as a dependent on her parent’s return. She doesn’t receive any scholarships. ?? ??

Example : Liz is a senior at UConn and a member of the swimming team. She receives a full scholarship that pays for her tuition, fees, books, and room and board. Liz’s parents claim her as a dependent. Can Liz’s parents claim the education credit? ??

FEDERAL TAX PAYMENTS Employers are required to withhold federal income tax from compensation paid to their employees See W-2, Box 2

Estimated tax payments (MTG Paragraphs ) The tax law requires those individuals with gross income from sources other than employee compensation to make estimated tax payments at specific times during the year. Federal income taxes are prepaid during the year! prepaid during the year! KEY POINT!