Figuring Self-Employment Tax There are three steps to figure the SE tax you owe. cheap hotels in SopotFigure your net self-employment income. Figure your net earnings from self-employment. Multiply your net earnings by the tax rate. Step 1--Figure Your NetSelf-Employment Income Net SE income usually includes all business income less allbusiness deductions allowed for income tax purposes. You must claimall allowable deductions when figuring net SE income. Your net SEincome is used to figure your net earnings from self-employment. SeeStep 2--Figure Your Net Earnings From Self-Employment,later. You must figure your net income from self-employment byusing the same accounting method you use for income tax purposes. Your net SE income is shown on the lines of the followingschedules: Schedule C (Form 1040) Line 31 Schedule C-EZ (Form 1040) Line 3 Schedule F (Form 1040) Line 36 Schedule K-1 (Form 1065) Line 15a Schedule K-1 (Form 1065-B) Line 9 More than one business.If you have more than one trade or business, you must combine thenet profit (or loss) from each business to determine your net SEincome. A loss from one business will reduce your profit from anotherbusiness. File one Schedule SE showing the net SE income, but file aseparate Schedule C or F for each business. Example.You are the sole proprietor of two separate businesses. You operatea restaurant that made a net profit of $25,000. You also have acabinetmaking business that had a net loss of $500. You file ScheduleSE showing net SE income of $24,500. You must also file a Schedule Cfor each business--a Schedule C for the restaurant showing yournet profit of $25,000, and another Schedule C for the cabinetmakingbusiness showing your net loss of $500. Church employee.If you are an employee of a church or church-related organizationthat elected exemption from social security and Medicare taxes, yournet SE income is the gross income you received for your services(gross income without any deductions). Recapture of depreciation.If you recaptured any depreciation, including any section 179deduction, because the business use of certain property was reduced to50% or less, these recaptured amounts are subject to the SE tax. Thisrule does not apply to amounts recaptured on the disposition ofproperty. For more information, see the instructions for Form 4797,Sales of Business Property. Employment credits.Use your reduced wage and salary expense deduction to determineyour net SE income if you claimed the following credits. Empowerment zone employment credit Indian employment credit Welfare-to-work credit Work opportunity credit Deductions and exemptions.Do not reduce your SE income by any of the following. Deductions for personal exemptions for yourself, yourspouse, or dependents. The standard deduction or itemized deductions. The net operating loss deduction. Nonbusiness deductions (including contributions on yourbehalf to a pension, profit-sharing plan, annuity plan, Keogh, SIMPLE,or SEP plan). The self-employed health insurance deduction. The deduction for one-half of your SE tax. Example.You own a grocery store that had the following income, expenses,and net operating loss carryover for the year. Gross income $87,400 Salaries 30,000 Rent 6,000 Heat, light, and air conditioning 2,400 Other expenses 1,900 Gain on refrigerator sale 350 Fire loss on store building 1,200 Net operating loss carryover 1,000 To figure taxable income, consider all the above items. But tofigure net self-employment income, use only the following. Gross income $87,400 Expenses:  Salaries $30,000  Rent 6,000  Heat, light, and air conditioning 2,400  Other expenses      1,900     40,300 Net profit $47,100 The $47,100 is your net SE income. The refrigerator sale, the fireloss, and the net operating loss carried over from a previous year arenot included in the calculation. Step 2--Figure Your Net EarningsFrom Self-Employment The net SE income subject to SE tax is called net earnings fromself-employment. Minimum earnings subject to SE tax.You must have $400 or more of net earnings from self-employment tobe subject to the tax. For this purpose, net earnings are figured online 4 of Schedule SE, Section A or line 4c of Schedule SE, Section B.If your net earnings are less than $400, you do not have to fileSchedule SE (Form 1040) or pay the tax, unless you performed servicesfor a church as an employee and received income of $108.28 or more. How to figure net earnings.There are three ways to figure net earnings from self-employment. The regular method The nonfarm optional method The farm optional method You must use the regular method unless you are eligible to use oneor both of the optional methods. See keno strategieFigure 1. Can I Use theOptional Methods?. Why use the optional methods?You can generally use the optional methods (discussed later) whenyou have a loss or a small amount of net income from self-employmentand any one of the following applies. You want to receive credit for social security benefitcoverage. You incurred child or dependent care expenses for which youcould claim a credit (this method will increase your earned income,which could increase your credit). You are entitled to the earned income credit (this methodwill increase your earned income, which could increase yourcredit). Figure 1. Can I Use the Optional Methods? Regular Method Multiply your net SE income by 92.35% (.9235) to get your netearnings under the regular method. See Short Schedule SE,line 4, or Long Schedule SE, line 4a. You must use the regular method unless you are eligible to use oneor both of the optional methods. Nonfarm Optional Method By using the nonfarm optional method, you can continue paying SEtax for your social security coverage when your net profit for theyear is small or you have a loss. But you may not use this method toreport an amount less than your actual net earnings fromself-employment. Your actual net earnings are your net earningsfigured using the regular method, explained above. Use the nonfarm optional method only for SE income that does notcome from farming. You may use this method if you meet all thefollowing tests. Your net nonfarm profits as shown on line 31 of Schedule C(Form 1040), line 3 of Schedule C-EZ (Form 1040), and line 15aof Schedule K-1 (Form 1065), are less than $1,733. Your net nonfarm profits are less than 72.189% of your grossnonfarm income. You are self-employed on a regular basis. This means thatyour actual net earnings from self-employment were $400 or more in atleast 2 of the 3 tax years before the one for which you use thismethod. The net earnings can be from either farm or nonfarm earningsor both. You have not previously used this method more than 4 years(there is a 5-year lifetime limit). The years do not have to be oneafter another. Gross income of $2,400 or less.If your gross income from all nonfarm trades or businesses is$2,400 or less and you meet the four tests in the preceding paragraph,you may report two-thirds of the gross income from your nonfarmself-employment as net earnings from self-employment. Example 1.Ann Green had actual net earnings from self-employment of $800 in1997 and $900 in 1998 from her craft business. She meets the test forbeing self-employed on a regular basis. Her gross income and netprofit in 1999 are as follows: Gross income $2,100 Net profit $1,200 Because her net profit is less than $1,733 and less than 72.189% ofher gross nonfarm income, Ann may use her nonfarm optional method netearnings of $1,400 (two-thirds of $2,100). Example 2.Assume that in Example 1 Ann's gross income is $1,000 and her netprofit is $800. She must use the regular method to figure her netearnings. She cannot use the nonfarm optional method because her netprofit is not less than 72.189% of her gross nonfarm income. Example 3.Assume that in Example 1 Ann has a net loss of $700. In thissituation, she may use $1,400 (two-thirds of $2,100) as her netearnings under the nonfarm optional method. Example 4.Assume that in Example 1 Ann has gross income of $525 and a netprofit of $175. In this situation, she would not pay any SE tax undereither the regular method or the nonfarm optional method because hernet earnings under both methods are less than $400. Gross income of more than $2,400.If your gross income from all nonfarm trades or businesses is morethan $2,400 and you meet the four tests for using the nonfarm optionalmethod, you may report $1,600 as your net earnings from nonfarmself-employment. Example 1.John White runs an appliance repair shop. His actual net earningsfrom self-employment were $8,500 in 1996, $10,500 in 1997, and $9,500in 1998. He thus meets the test for being self-employed on a regularbasis. His gross income and net profit in 1999 are as follows: Gross income $12,000 Net profit $1,200 Because his net profit is less than $1,733 and less than 72.189% ofhis gross nonfarm income, John may use $1,600 as his net earnings. Example 2.Assume that in Example 1 John's net profit is $1,800. He must usethe regular method. He cannot use the nonfarm optional method becausehis net nonfarm profit is not less than $1,733. Example 3.Assume that in Example 1 John has a net loss of $700. He may usethe nonfarm optional method and report $1,600 as his net earnings fromself-employment. Farm Optional Method If you are in the farming business, either as an individual or as apartner, you may be able to use the farm optional method to figureyour net earnings from farm self-employment. Like the nonfarm method,this method also allows you to continue paying SE tax for your socialsecurity coverage when your net profit for the year is small or youhave a loss. Gross income of $2,400 or less.If your gross income from farming is $2,400 or less, you may reporttwo-thirds of your gross income as your net earnings from farmself-employment. Gross income of more than $2,400.If your gross income from farming is more than $2,400 and your netfarm profits are less than $1,733, you may report $1,600 as your netearnings from farm self-employment. But if your gross income fromfarming is more than $2,400 and your net farm profits are $1,733 ormore, you cannot use the optional method. Optional earnings less than actual earnings.If your net earnings under the farm optional method are less thanyour actual net earnings, you can still use the farm optional method.For example, your actual net earnings from self-employment are $425and your net earnings figured under the farm optional method are $390.You owe no SE tax if you use the optional method, because your netearnings under the farm optional method are below $400. Gross income from farming.Farming income includes what you receive from cultivating the soilor raising or harvesting any agricultural commodities. It alsoincludes income from the operation of a livestock, dairy, poultry,bee, fish, fruit, or truck farm, or plantation, ranch, nursery, range,orchard, or oyster bed. This includes income in the form of cropshares if you materially participate in production or management ofproduction. If you receive government commodity program payments on land yourent out, do not include these payments unless you meet the materialparticipation test. For more information on material participation,see chapter 15 in Publication 225. Malaga hotelsCash method of accounting.If you file your return using the cash method and are not a memberof a farming partnership, your gross income from farming willordinarily be the amount shown on line 11 of Schedule F. hotel rooms KeszthelyAccrual method of accounting.If you file your return using an accrual method and are not amember of a farming partnership, your gross income from farming willordinarily be the amount shown on line 51 of Schedule F. Gross income from a farm partnership.Your gross income under the farm optional method includes yourdistributive share of a partnership's gross income from farming. To determine your distributive share of gross income from a farmpartnership, the partnership does the following. Figures the partnership's gross income from farming. ERROR MSGSubtracts any guaranteed payments to partners for servicesor the use of capital if the payments are determined without regard topartnership income. Determines your share of what is left. The gross income thatremains after steps (1) and (2) is divided among the partners in thesame way they share the ordinary income (or loss) of the partnershipunless the partnership agreement provides otherwise. The result determined in (3) above is your distributive share ofthe partnership's gross income from farming. If you have no othergross income from farming, including guaranteed payments discussednext, use this distributive share of gross income to determine whetheryou can use the farm optional method to figure your net earnings fromself-employment. Guaranteed payments.Any guaranteed payments you receive from a farm partnership thatare determined without regard to partnership income are gross incomefrom your farming business (not the partnership's). Use the total ofthese guaranteed payments, your distributive share of gross incomefrom a farm partnership, and any other gross income you receive fromfarming, to determine whether you can use the farm optional method tofigure your net earnings from self-employment. Using Both Optional Methods You may not combine farming income with nonfarm income to figureyour net earnings under either of the optional methods. If you useboth optional methods, you must add together the net earnings figuredunder each method to arrive at your total net earnings fromself-employment. You may report less than your total actual netearnings from farm and nonfarm self-employment but not less thanactual net earnings from nonfarm self-employment. If you use bothoptional methods, you may report no more than $1,600 as your combinednet earnings from self-employment. Example 1.You are a self-employed farmer. You also operate a retail grocerystore. Your gross income, actual net earnings from self-employment,and optional farm and optional nonfarm net earnings fromself-employment are as follows: Farm Nonfarm Gross income $1,200 $1,500 Actual net earnings 900 500 Optional net earnings ( 2/3 ofgross income) 800 1,000 You may figure your net earnings from self-employment in any of thefour combinations shown below: 1 2 3 4 Actual farm net  earnings $900 -- $900 -- Optional farm net  earnings -- $800 -- $800 Actual nonfarm net  earnings 500 500 -- -- Optional nonfarm  net earnings        --         --     1,000      1,000 Net earnings $1,400 $1,300 $1,900 $1,600* *Limited to $1,600 because both optionalmethods are used. Example 2.Assume that in Example 1 your gross income, actual net earningsfrom self-employment, and 2/3 of your gross income fromself-employment are as follows: Farm Nonfarm Gross income $2,600 $1,000 Actual net earnings 400 800 2/3 of gross income 1,733 667 Your net earnings from self-employment may be either of the amountsfigured below: 1 2 Actual farm net earnings $400 -- Optional farm net earnings -- $1,600* Actual nonfarm net earnings 800 800 Optional nonfarm net earnings        --         -- Net earnings $1,200 $2,400 *Limited to $1,600. You may not use the nonfarm optional method for the year becauseyour actual net earnings from nonfarm self-employment ($800) are notless than 72.189% of gross nonfarm income (.72189 $1,000 =$721.89). Step 3--Multiply Your Net Earningsby the Tax Rate Multiply the net earnings you figured in Step 2 by the tax rate toget your SE tax. The SE tax rate is 15.3% (12.4% social security taxplus 2.9% Medicare tax). It is the same for net earnings figured undereach method. Special rules (explained later) apply to this computation if eitherof the following applies. Your combined wages, tips, and net earnings are more than$72,600. You use a fiscal tax year. Maximum earnings subject to SE tax.Only the first $72,600 of your combined wages, tips, and netearnings in 1999 is subject to any combination of the 12.4% socialsecurity part of SE tax, social security tax, or railroad retirement(tier 1) tax. All your combined wages, tips, and net earnings in 1999 are subjectto any combination of the 2.9% Medicare part of SE tax, socialsecurity tax, or railroad retirement (tier 1) tax. If your wages and tips are subject to either social security orrailroad retirement (tier 1) tax, or both, and total at least $72,600,you do not have to pay the 12.4% social security part of the SE tax onany of your net earnings. However, you must pay the 2.9% Medicarepart of the SE tax on all your net earnings. Fiscal tax year.If you use a tax year other than the calendar year, you must usethe tax rate and maximum earnings limit in effect at the beginning ofyour tax year. Even if the tax rate or maximum earnings limit changesduring your tax year, you should continue to use the same rate andlimit throughout your tax year. Regular Method The following paragraphs explain how to figure the SE tax using netearnings under the regular method. Net earnings and wages not more than $72,600.If your net earnings from self-employment plus any wages and tipsare not more than $72,600, and you do not have to use LongSchedule SE, use Short Schedule SE. On line 5,multiply your net earnings by 15.3% (.153). The result is your SE tax. Example 1.You have $30,000 in net SE income and receive no wages subject tosocial security and Medicare taxes for the year. Multiply the $30,000by 0.9235 on Short Schedule SE to get your net earningsfrom self-employment of $27,705. Your SE tax is 15.3% (.153) of$27,705, or $4,238.87. Example 2.You have $20,000 in net SE income and receive $15,000 in wagessubject to social security and Medicare taxes for the year. Multiplythe $20,000 by 0.9235 on Short Schedule SE to get your netearnings from self-employment of $18,470. Your SE tax is 15.3% (.153)of $18,470, or $2,825.91. Net earnings more than $72,600 and no wages.If you had no wages, had net earnings from self-employment of morethan $72,600, and do not have to use Long Schedule SE, useShort Schedule SE. On line 5, multiply the line 4 netearnings by the 2.9% (.029) Medicare tax and add the result to$9,002.40 (12.4% of $72,600). The total is your SE tax. Example.You have $80,000 in net SE income and receive no wages subject tosocial security and Medicare taxes for the year. Multiply the $80,000by 0.9235 on Short Schedule SE to get your net earnings of$73,880. Since only $72,600 of your earnings is subject to the socialsecurity part of the SE tax, your tax for this part is $9,002.40(12.4% of $72,600). Since all of your net earnings are subject to the Medicare part ofthe SE tax, multiply $73,880 by 2.9% (.029) on Short Schedule SEfor the Medicare part. The result is $2,142.52. Add this to$9,002.40 for a total SE tax of $11,144.92. Net earnings and wages more than $72,600.If your net earnings from self-employment plus any wages and tipsare more than $72,600, you must use Long Schedule SE.Subtract your total wages and tips from $72,600 to find themaximum earnings subject to the 12.4% social security part of the tax.If more than zero, multiply the amount by 12.4% (.124). The result isthe social security tax amount. Then multiply your net earnings fromself-employment by 2.9% (.029). The result is the Medicare tax amount.The total of the social security tax amount and the Medicare taxamount is your SE tax. Example.You have $80,000 in net SE income and receive $10,000 in wagessubject to social security and Medicare taxes for the year. Your netearnings are figured on Long Schedule SE, line 4a to be$73,880. Next, subtract your wages of $10,000 from $72,600, themaximum income subject to the social security part of the SE tax. Theresult is $62,600. Since only $62,600 of your earnings is subject tothe social security part of the SE tax, your tax for this part is12.4% (.124) $62,600, or $7,762.40. Since all your net earnings are subject to the Medicare part of theSE tax, multiply all your net earnings from self-employment, $73,880,by 2.9% (.029) on Long Schedule SE for the Medicare part.The result is $2,142.52. Add this to the $7,762.40 figured above fortotal SE tax of $9,904.92. Optional Methods If your net earnings under the nonfarm optional method or under thefarm optional method are $400 or more, use Long Schedule SEto figure your SE tax. Long Schedule SE is reproducedon page 15. Effect on taxes.If you use either or both optional methods, you must figure and paythe SE tax due under these methods, even if you would have had asmaller tax or no tax using the regular method. The optional methods may be used only to figure your SE tax. Tofigure your income tax, include your actual SE income in gross income,regardless of which method you use to figure SE tax.