Beyond EITC, Effective Tax Planning and Assistance National Disability Institute Mayor’s Leadership Academy Boston, MA – September 27, 2011

Selected Issues Affecting Self- Employed Taxpayers Is free tax preparation assistance available? Does the taxpayer have net earnings from self- employment? Must allowable expenses be deducted?

Is Free Tax Preparation Assistance Available? Many self-employed taxpayers can file a Schedule C-EZ; however, a number of issues require a Schedule C. Schedule C-EZ is in scope for Volunteer Income Tax Assistance (VITA) Programs, but Schedule C historically has not been. Note: Beginning in the 2011 tax season Schedule C is in scope if the only reason is expenses in excess of $5,000 (but not more than $10,000).

Schedule C Pilot In the past some tax assistance programs decided to train for and prepare Schedule C returns. CFED’s Self- Employment Tax Initiative (SETI) provided funding to support this activity in selected cities. Recognizing the need to properly serve self-employed taxpayers, IRS - SPEC, the National Community Tax Coalition, and SETI established a pilot to prepare certain Schedule C returns under closely monitored conditions. A certification test and experience requirements for volunteers were developed. Out of scope issues were identified.

Schedule C Pilot – Out of Scope Returns Total expenses exceeding $25,000 Businesses with inventory Businesses with employees Business use of the home except for day care providers Accrual basis method of accounting Net Operating Losses (no resulting carryback or carry- forward)

Schedule C Pilot – Second Year In the first year, partner-developed training and tax preparation by 12 participating programs were reviewed in visits by IRS-SPEC. Based on the results from the first year, the pilot will be continued for a second year. A uniform training package is being developed. Testing of volunteers and tracking of results will continue.

Does the Taxpayer Have Net Earnings From Self-Employment? This determination is critical to knowing if self- employment tax will be due and if the Earned Income Tax Credit (EITC) or Additional Child Tax Credit (ACTC) are available. Net earnings from self-employment of $400 or more are subject to self-employment tax. Income, even though “earned” by doing something to get it is not earned income for the EITC or ACTC unless it is net earnings from self- employment (assuming it is not employee compensation such as salaries and wages).

Was The Income Actually Earned? Due to the computation of the EITC more income is sometimes better in terms of a refund. Careful documentation of income received is needed, including payers, amounts, and dates. A separate bank account is best.

Is the Activity Self-Employment? The following items can be helpful in establishing self-employment : A business plan or other documentation showing an intent to regularly and continuously engage in the activity to make a profit. Treating it like a business – keeping records of income and expenses. Documentation that the taxpayer is holding him or herself out as being self-employed and offering services to others.

An IRS Position The IRS has provided two examples of activities that are not considered self-employment even though the taxpayers received Forms 1099-MISC with entries in Box 7, non-employee compensation, and worked for the income. In both examples the taxpayer does not provide services to others or otherwise appear to be in a trade or business. Source: =229048,00.html =229048,00.html

An IRS Position - Continued The situations involve: A taxpayer who is not a trained nurse or therapist paid by an insurance company to care for their disabled or injured spouse. A taxpayer paid by a state agency to care for his grandchildren so that his daughter can work. In both situations the taxpayer is advised to report the income on Line 21 of Form 1040.

An IRS Position - Continued Consequences of the IRS Position: The taxpayer is not subject to self- employment tax. The taxpayer is not entitled to either the EITC or the ACTC.

Must Allowable Expenses Be Deducted? For many taxpayers, more deductions result in less tax liability. For self-employed taxpayers receiving the EITC for qualifying children, the opposite is sometimes true. At lower income levels, more deductions can reduce the EITC at a greater rate than a reduction in income tax and self-employment tax because of the percentage differences between the EITC and the taxes.

The IRS Position In 1956, in Revenue Ruling , 2 C.B. 564, the IRS ruled that “every taxpayer, with the exception of certain farm operators, must claim all of his allowable deductions, including depreciation, in computing his net earnings from self- employment for self-employment tax purposes.” This Revenue Ruling is still in effect and has been cited in a subsequent Revenue Ruling (57-538, C.B. 55) and a Chief Counsel Advice issued in 2000 ( dated 6/2/2000).

Thank you for attending this presentation! Marshall J. Hunt, CPA Director, Tax Assistance Program Accounting Aid Society 7700 Second Avenue, Suite 314 Detroit, MI Website: