 Income tax 2022-2023, figuring self-employment S.E. tax. Let's do some wealth preservation with some tax preparation. Most of this information comes from the tax guide for small business for individuals who use Schedule C. Publication 334 tax year 2022. You can find on the IRS website, irs.gov, irs.gov. Looking at the support accounting instruction by clicking the link below giving you a free month membership to all of the content on our website broken out by category, further broken out by course. Each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files, and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Income tax formula, we're focused on line one income. Remember on the first half of the income tax formula is in essence an income statement although just an outline other forms and schedules flowing into these line items. One of those being the Schedule C, it having business income minus business expenses. The net business income flowing into line one income of the income tax formula. Looking at the page one of the Form 1040, remembering the Schedule C flows into the Schedule 1 which flows into the first page of Form 1040 line number eight. The Schedule C is a profit or loss from business in essence income statement format income minus expenses. We now want to think about the self employment tax and recall that when we talk about the self employment tax in general, it's similar to the payroll taxes that you may have or would have if you were a W2 employee where you would be paying half the self employment tax as the employee and the employer would be paying half the self employment tax. When we talk about the Schedule C, we don't have any payroll if we are our own employees. In other words, we might have other employees that we deal with payroll but if we don't have any other employees or if we do have the other employees then we're not our own employee. We're not issuing ourselves a W2 in a Schedule C situation. Typically instead we're going to in essence take the income statement the income minus the expenses and the net income is what we will then use to figure the self employment tax which is equivalent in some ways to that payroll taxes and it basically means that we're going to act as the employer and employee for the self employment tax that we're going to have to be calculating and paying half of that self employment tax possibly being an above the line deduction on a Schedule 1. Alright, that's the general overview. We'll get into it in a little bit more detail now. So we got the self employment tax, the SE tax, caution. The SE tax rules apply no matter how old you are and even if you are already receiving social security and Medicare benefits. So when we think about self employment tax notice that you often hear social security you think of when you're paying into social security or you might be thinking of when you're getting the money out from social security in retirement. Remembering that social security used to be thought of as more of a safety net program but is now almost thought of as more of a government funded basically or we put into this government program for everybody's partial retirement program in essence and therefore if you put money into social security you expect to get something in return from social security although I wouldn't completely bet on that if you're a younger individual because the social security is having you know it's going to run into a wall somehow unless they make some changes to it at some point in time but that's the general concept of it. We of course are talking here about the pain into the social security system when you have your own business and doing so therefore not through the payroll taxes but the self employment tax. Alright who must pay the self employment tax, the SE tax? Generally you must pay SE self employment tax and file schedule SE form 1040 if your net earnings from self employment were $400 or more. So clearly if you have a loss on your schedule C income you're not going to be having the self employment tax because it's going to be subject or based on your income in a similar way if you are a W2 employee your income from the employer is what the basis is to figure the self employment or in that case the payroll taxes social security and Medicare and in this case the income to us is the net income from the schedule C that's going to be the starting point to calculate the social security and Medicare if we didn't have any income or if we had a loss from that then we're not going to be paying the social security and Medicare. So use schedule SE to figure net earnings from self employment. So sole proprietor or independent contractor if you are self employed as a sole proprietor or independent contractor you generally use schedule C form 1040 to figure your earnings subject to self employment tax. Self employment tax rate so the 2022 SE self employment tax rate on net earnings is 15.3 12.4 social security tax and 2.9 Medicare tax. Let's break that down in a little bit more detail here so if I pull out the trustee calculator we're going to say I'm trying to make it smaller not bigger. Alright so if you had your W2 withholdings as opposed to the self employment tax and you were to look at your pay stub then the rate for social security is usually 0.062 so and then the and then if you double that times 2 that gets to that 12.4 so the 12.4 percent is the employer and employee portion like equivalent to the employee or employee portion if you were a W2 employee and you had an employer and employee portion that's so on our net income on the schedule C we're paying the equivalent of the employer and employee portion in essence so similar kind of thing for the 2.9 if you were to look at like a W2 withholding it would be 0.0145 the employee portion times 2 for the employer portion as well and hold on a second 0.0145 times 2 that's going to be if I move the decimal two places over 2.9 and if I add that to the 12.4 hold on a second if I take the 12.4 plus the 2.9 that's going to get to that 15.3 so there's where they're getting that 15.3 now you still need to be able to break out between the social security rate and the Medicare rate because there could be some differences if you go over the cap or the threshold for social security then you're not going to have to pay any more social security above that amount we'll talk about that a little bit later so you have to think of these rates different not just the 15.3 all the time and if you make a lot of income you might have to pay added Medicare taxes over a certain threshold as well so maximum earnings subject to SE tax only the first 147,000 of your combined wages tips and net earnings in 2022 is subject to any combination of the 12.4 social security part of SE tax social security tax or the tier one part of railroad retirement tax so now that 147 so if your income minus your expenses on your schedule C for example came up to 200,000 you would think that you would have to be paying the tax on the 200,000 but no for the social security portion only you have the cap at 147,000 why would that be you might ask that seems odd why would I stop paying taxes over that threshold because it's not a general tax here because we think of social security more as a retirement program or something that everybody should get a benefit from and therefore you have to kind of compare it to the calculations of the benefits that you're going to be getting so in other words the higher you the more money you put in the social security the more you should get back it's like a retirement type of program and the benefits of course are reversed structured so that as your income goes up the amount of benefits you get in payments in retirement goes down and after you hit a certain threshold then you don't get any more benefit on the benefit side if you put more money in so that's kind of the justification of a cap on the social security because you're not getting any more benefit by putting more money into the social security when you are at retirement age alright so we don't have that cap on the Medicare side of things you'll note and that would be maybe because we still think of Medicare more as a safety net program not as like a government kind of sponsored retirement kind of fun program so all of your combined wages tips and net earnings in 2022 are subject to any combination of the 2.9 Medicare part of the tax or Medicare part of railroad retirement tax if your wages and tips are subject to either social security tax or the tier one part of railroad retirement tax or both and total at least 147,000 do not pay the 12.4% social security part of the SE tax on any of your net earnings however you must pay the 2.9 Medicare part of the SE tax on all your net earnings okay so there's the cap applied just to the social security side not to the Medicare side and then if we go to the Medicare master Medicare side we have this additional Medicare tax if your income goes above a certain amount so a 0.9% additional Medicare tax may apply to you if your net earnings from self-employment exceed a threshold based on your filing status so you can take a look at it for more information self-employment tax in Chapter 1 and form 8959 and its instructions now obviously tax software kind of helps us with this it's kind of weird the way this happens then because we're talking social security has basically a flat tax type of system one rate up until you hit the cap and then you don't pay any of it at that point because of this kind of retirement structure but Medicare seems more like like it's still a safety net program and we have now added like a progressive tax tier to it in other words meaning you pay one rate which is easy to calculate until you get over a certain threshold and then you've got the additional Medicare which in essence is a higher rate now you're adding on another rate if your income is over a certain threshold right so special rules and exceptions aliens generally resident aliens must pay S.E. tax under the same rules that apply to U.S. citizens non-resident aliens are not subject to S.E. tax unless an international secure social security arrangement also known as totalization agreement in effect determines that they are covered under the U.S. social security system now aliens it becomes somewhat of a problem when you're dealing with people that aren't citizens because now you have a system you're thinking if you're going to be putting money into the social security Medicare then you would think that you have you should be benefiting from the system so if you put money into the social security and now we think of social security as like a government funded retirement plan but you're not able to get the benefits from the government funded retirement plan system because you're not a citizen or something like that then it doesn't seem fair to be taking the money out for that reason which again leads to kind of weird situations because normally if you asked a U.S. citizen would you like to put money into the social security system or not and then just say for your own retirement I think most people would say I'll choose not to given the fact that the social security system is going to it looks like it's heading towards off the cliff at some point in time in the future but so again that's kind of it's kind of weird but you can see the rationale I need not explain my rationale to you or to any other member of this crew they're saying well if you're if it's an alien that it doesn't make sense to force them to put in certain situations to the retirement plan that they don't have the capacity to get a benefit from and so on so however residents of the U.S. Virgin Islands Puerto Rico Guam and the Commonwealth of Northern Mariana Islands and American Samoa are subject to S.E. tax as they are considered U.S. residents for S.E. tax purposes so for more information on aliens you can see publication 519 U.S. tax guide for more information there so child employed by parent so you are not subject to S.E. self employment tax if you are under age 18 and you are working for your father or mother so you can simplify things a little bit in that situation which employee if you work for a church or a qualified church controlled organization other than as a minister member of a religious order or a Christian science practitioner that elected an exemption from the Social Security Medicare taxes you are subject to S.E. tax if you receive 108 dollars and 28 cents now that number again is one of these rules that's quite low like why do you even need to cover because it's so like ridiculously like seems low and that's because they haven't really it's one of those laws they haven't changed like forever so they still kind of have that number hanging out there it hasn't increased with inflation for example so or more in wages from the church or so for more information you can see publication 517 Social Security and other information for members of the clergy and religious workers so fishing crew members there's all these weird regulations with regards to fishing crews for some reason as well which I'm not specialized in so if you are a member of the crew on a boat that catches fish or other aquatic life your earnings are subject to S.E. self employment tax if all the following conditions apply one you do not get any part any pay for the work except your share of the catch or a share of the proceeds from the sale of the catch unless the pay meets the following conditions A. the pay is not more than $100 per trip B pretty low threshold B. the pay is received only if there is a minimum catch and C. the pay is solely for additional duties such as mate engineer or cook for which additional cash pay is traditional in the fishing industry two you get a share of the catch or share of the proceeds from the sale of the catch three your share depends on the amount of the catch and four the boats operating crew normally numbers fewer than 10 individuals an operating crew is considered as normally made up of fewer than 10 if the average size of the crew on trips made during last year calendar quarters is fewer than 10 okay it's kind of a special situation notary public so fees you receive for services you perform as a notary public are reported on schedule C but are not subject to SE tax see the instructions for schedule SE form 1040 another somewhat unusual situation state or local government employee you are subject to SE self-employment tax if you are an employee of a state or local government are paid solely on a fee basis and your services are not covered under a federal state social security agreement then we've got the foreign government or international organization employee so you are subject to SE tax if both the following conditions are true number one you are a US citizen employed in the United States Puerto Rico Guam America Samoa the Commonwealth of North Mariana Islands and the US Virgin Islands by A, a foreign government B, a wholly owned agency of a foreign government or C an international organization and 2, your employer is not required to withhold social security and Medicare taxes from your wages alright US citizen or resident alien residing abroad so if you are a self-employed US citizen or resident alien living outside the United States and most cases you must pay social security tax or self-employment tax the foreign earnings from self-employment can't be reduced by your foreign-earned income exclusion when computing the self-employment tax so it gets a little bit messy of course in these types of situations because we are going to have tax agreements with other countries to try to avoid a double taxation type of situation so you got to do some more research on your particular situation on those cases exception the United States has social security agreements with many countries to eliminate double taxation under two social security systems so now you are in a special situation in that you have an agreement because the two countries have their own social security systems and the whole idea of the social security system is that you are paying into it and you are going to get some benefit from the state funded social security kind of system so under these agreements you must generally only pay social security and Medicare taxes to the country in which you live the country to which you must pay the tax will issue a certificate that services as proof that serves as proof of exception from social security tax in the other country so for more information you can see the instructions for schedule S.E. form 1040 so more than one business so if you have earnings subject to self employment tax from more than one trade, business or profession you must combine the net profit or loss from each to determine your total earnings subject to S.E. tax so if you have multiple schedule C's for example you would have to combine the bottom lines of the schedule C's and that would pull into the self employment and then calculate the total employment based on the total earnings so a loss from one business reduces your profit from another so what if you had one business that made 100,000 and the other business that lost 25,000 then the net 75,000 you would think then would be the number subject to the self employment so community property income if any of the income from a trader business other than partnership is community property income under state law is included in the earnings subject to self employment S.E. tax of the spouse carrying on the trade or business gain or loss do not include earnings subject to S.E. self employment tax a gain or loss from the disposition of property that is neither stock in trade nor held primarily for sale to customers so it does not matter whether the disposition is a sale and exchange is a voluntary conversion so when we think about the different types of incomes you can think about income that is going to be subject to self employment tax or not so if you have W-2 type of income for example then you are paying Social Security and Medicare but you are doing that through the withholdings between the employer employee situation so they are withholding Social Security and Medicare at least you are part then you might have a Schedule C type of business in which case you would be subject to self employment tax because it is an active business if you have investments in stocks and bonds or something like that then or interest that you are generating from investments then you would think that that is more of a passive investment and you would not have the gains and losses on the dividends you would think or the interest you are not going to generally calculate self employment tax on those and you are not generally going to be taxed on self employment tax on gains and losses that are non business property like selling stocks for example so lost income payments if you are self employed and reduce or stop your business activities any payments you receive from insurance or other sources for the lost business income is included in earnings from self employment tax because it is still kind of business related if you are not working when you receive the payment it still relates to your business and included in earnings subject to self employment tax so you might say hey I closed my business or whatever but then I still got income that is basically tied to the business so you would think it would be still kind of like business income subject then to self employment tax so figuring earnings subject to self employment tax methods for figuring net earnings so there are three ways to figure net earnings from self employment one the regular method two the non farm optional method three the farm optional method you must use the regular method to the extent you do not use one or both of the optional methods so why use an optional method you might ask so you may want to use the optional methods discussed later when you have a loss or a small profit and any one of the following applies you want to receive credit for social security benefit coverage you incurred child or dependent care expenses for which you could claim a credit an optional method may increase your earned income which could increase your credit so this is kind of a weird situation because you have those situations where usually income is bad for taxes but the earned income credit is trying to incentivize people to earn income so earned income can actually be good there which leads to these kind of weird situations to try to increase the earned income which could be beneficial for tax so you are entitled to the earned income credit an optional method may increase your earned income normally bad but possibly good sometimes for the earned income credit which could increase your credit you are entitled to the additional child tax credit an additional method may increase your earned income which could increase your credit so effects of using an optional method an optional method could increase your SE tax self-employment tax paying more SE self-employment tax could result in your getting higher benefits when you retire most people probably wouldn't generally want to do that because because you are paying in and you are going to get the benefit in the future so usually people are going to say hey look I would like to pay as little self-employment tax as I can at this point in time because I want to get the benefit now as opposed to getting some benefit when I in the benefit program but you might be in some situations where you are saying hey I need to increase my payments into self-employment so that I could increase the amount of benefit that I am going to be getting into retirement age from social security so using the optional methods may also decrease your AGI due to the deduction for one half of SE tax on form 1040 or form 1040 SR so we are paying both the employer and employee portion of the tax in essence the equivalent of with the self-employment tax equivalent to the payroll taxes half of that is actually deductible above the line as an adjustment to income which could lower the AGI it will lower your adjusted gross income if you increase that number which may affect your eligibility for credits deductions or other items that are subject to AGI limits in other words that number the AGI is what is used when you have phase outs for certain credits and deductions so if you have a higher self-employment tax you are going to have a higher deduction that is an above the line deduction which could lower your AGI which may make it easier to qualify for other deductions or credits in some cases so figure your AGI with and without using the optional methods to see if the optional methods will benefit you so if you use either or both optional methods you must figure and pay the SE self-employment tax due under these methods even if you would have had a smaller tax or no tax using the regular method the optional methods may be used only to figure your SE self-employment tax to figure your income tax include your actual earnings in gross income regardless of which method used to determine self-employment tax so the regular method to figure net earnings using the regular method multiply your self-employment earnings by 92.35 so this is where it deviates a little bit from basically the idea that you're just going to take the self-employment earnings the bottom line of the schedule C and multiply it by in essence the employer and employee of the payroll tax as being the self-employment tax they're going to reduce your earnings a little bit because we're going to multiply the earnings times 0.9235 so which is good although a little bit confusing so for your net earnings figure using the regular method C line 4A of your schedule C line 40 net earnings figured using the regular method are also called actual net earnings all right non-profit optional method so use the non-profit optional method only for earnings that do not come from farming so this is non-farm optional method excuse me so you may use this method if you meet all of the following number one you are self-employed on a regular basis the means that your actual net earnings from self-employment were $400 or more in at least two of the three tax years before the one for which you use this method for this purpose the prior year net earnings can be from either farm or non-farm earnings or both two you have used this method less than five years this is a five-year lifetime limit the years do not have to be one after another three your net non-farm profits were A less than $6,540 and B less than 72.189% of your gross non-farm income I used the farm optional method only for earnings from a farming business so again that's more of a special kind of situation or special industry and you can see publication 225 for information about that method joint return even if you file a joint return you cannot file a joint schedule S.E. so this is that weird one we saw in a prior presentation where now you have a situation where you have two people that are of course married which you would think would result in one individual for taxes which in essence it kind of does when you're talking about federal income taxes because you're going to file a joint return rate but for social security taxes you've got the situation that the benefits are applied to each social security number and therefore you have to break out between the two individuals which you could do possibly by being a partnership and then you'd have to file a partnership return or in some instances you may be able to file either two schedule C's or make an election so that you can basically still have two schedule S.E. calculations so they can apply the proper amounts to each individual social security number so this is true whether one spouse or both spouses have earnings subject to self-employment tax if both of you have earnings subject to self-employment tax each of you must complete a separate schedule S.E. attach both schedules to the joint return more than one business if you have more than one trade you must combine the net profit from each business to figure your S.E. tax a loss from one business will reduce your profit from another business file one schedule S.E. showing the earnings from self-employment but file a separate schedule C or F for each business so you have multiple businesses possibly two schedule C's for example then the schedule C's are separate you have two separate schedules but they might be owned by the one person with the same social security number and therefore the schedule S.E. you might have one schedule S.E. that's combining the incomes from the two businesses that are for the same social security number with regards to the self-employment tax let's look at an example you are the sole proprietor of two separate businesses you operate a restaurant that made a net profit of 25,000 you also have a cabinet-making business that had a net loss of $500 you must file a schedule C for the restaurant showing your net profit of 25,000 and another schedule C two schedule C's for the two business for the cabinet-making business showing your net loss of 500 you file one schedule S.E. because he's both the same social security number for the Social Security Medicare showing total earnings subject tax of 24,500 to 25,000 minus the $500 loss