1. Chapter 6D Self-Employment Taxes, Deductions Howard Godfrey, Ph.D., CPA Professor of Accounting ©Howard Godfrey-2015

3. Deductions for Self-Employed Taxpayers BIG 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

4. 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

5. 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

6. John Taxpayer, Ann Taxpayer – Slide # 1 John 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.

7. John Taxpayer, Ann Taxpayer – Slide # 2 The 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).

8. John Taxpayer, Ann Taxpayer – Slide # 3 Ann 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.

9. John Taxpayer, Ann Taxpayer – Slide #4 Assume 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).

10. John Taxpayer, Ann Taxpayer – Slide # 5 If 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.

11. John Taxpayer, Ann Taxpayer – Slide # 6

12. John Taxpayer, Ann Taxpayer – Slide # 7

13. 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?

16. 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?

19. 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.

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