Methods for Figuring Net Earnings

There are three ways to figure your net earnings from self-employment.

1. The regular method.
2. The farm optional method.
3. The nonfarm optional method.

You must use the regular method unless you are eligible to use one or both of the optional methods. See Figure 15-1.

Figure 15-1. Can I Use the Optional Methods?

Why use the optional methods? You may want to use the optional methods (discussed later) when you have a loss or a small amount of net income from self-employment 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 will increase your earned income, which could increase your credit.)
• You are entitled to the earned income credit. (An optional method will increase your earned income, which could increase your credit.)

Effects of using an optional method. Using an optional method could increase your self-employment tax. Paying more self-employment tax could result in your getting higher benefits when you retire.

If you use either or both optional methods, you must figure and pay the SE tax due under these methods even if you would have had a smaller tax or no tax using the regular method.

The optional methods are used only to figure your SE tax. To figure your income tax, include your actual SE income in gross income, regardless of which method you use to determine SE tax.

Regular Method

Multiply your net SE income by 92.35% (.9235) to get your net earnings under the regular method. See Short Schedule SE, line 4, or Long Schedule SE, line 4a.

Farm Optional Method

As a farmer who is either a sole proprietor or a partner in a farming business, you may be able to use the farm optional method to figure your net earnings from farm self-employment. This method allows you to continue paying SE tax for your social security coverage when your net profit for the year is small or you have a loss.

Optional earnings less than actual earnings. If your net earnings under the farm optional method are less than your actual net earnings, you can still use the farm optional method. Your actual net earnings are your net earnings figured using the regular method explained, earlier.

Example. Your actual net earnings from self-employment are $425 and your net earnings figured under the farm optional method are $390. You owe no SE tax if you use the optional method, because your net earnings under the farm optional method are below $400.

Table 15-1. Figuring Farm Net Earnings

Social security credits. Since two-thirds of $2,400 is $1,600, this counts for two credits ($1,600 x $780) for social security coverage in 2000. You cannot use the full amount of your gross income to determine credits when you are figuring the SE tax on only two-thirds of that amount.

Gross income from farming. Farming income includes what you receive from cultivating the soil or raising or harvesting any agricultural commodities. It also includes income from the operation of a livestock, dairy, poultry, bee, fish, fruit, or truck farm, or plantation, ranch, nursery, orchard, or oyster bed. This includes income you receive in the form of crop shares if you materially participate in production or management of production of the crop.

Your gross income from farming does not include any item listed earlier under Income not included in net earnings from self-employment.

Government commodity program payments. If you receive government commodity program payments on land you rent out, do not include these payments unless you meet one of the four material participation tests, explained earlier. Also, do not include any income from a nonfarm business.

Gross income from a farm sole proprietorship. If you operate your farm as a sole proprietorship, use the following table to determine your gross farm income.

Table 15-2. Gross Farm Sole Proprietorship Income

Gross income from a farm partnership. Your gross income under the farm optional method includes your distributive share of a partnership's gross income from farming.

To determine your distributive share of gross income from a farm partnership, the partnership does the following.

Table 15-3. Gross Farm Partnership Income

The result determined in (3) is your distributive share of the partnership's gross income from farming.

Net earnings from self-employment. Use the total of your guaranteed payments, your distributive share of gross income from a farm partnership, and any other gross income you receive from farming to determine whether you can use the farm optional method to figure your net earnings from self-employment.

Guaranteed payments from a farm partnership are gross income from your farming, not the partnership's.

Example. Bill and John are partners and share in ordinary income or loss on a 50-50 basis, with no guaranteed payments. If the partnership has $3,000 gross income from farming, each would have $1,500 gross income for purposes of the optional method.

If Bill had been guaranteed $1,000 without regard to partnership income, his gross income from farming would be $2,000 ($1,000 + (50% x $2,000)). John's gross income would be $1,000.

Two or more farms. If you run your own farm and are also a partner in a farm partnership, or in any way have gross farm income from more than one farm, you must add your farm income from all farming sources to get your total net earnings from farm self-employment. If you use the farm optional method, you must add all gross income from farming to make the $2,400 test.

Example. Your gross income from your own farm is $600 and your distributive share of the gross income from a farm partnership is $900. Since your gross income from farming is less than $2,400 ($1,500), your net earnings from self-employment under the farm optional method are $1,000 ( 2/3 x $1,500).

Nonfarm Optional Method

This is an optional method available for determining net earnings from nonfarm self-employment much like the farm optional method.

If you are also engaged in a nonfarm business, you may be able to use this method to compute your net earnings from self-employment from your nonfarm business. You can use this method even if you do not use the farm optional method for determining your net earnings from your farm self-employment and even if you have a net loss from your nonfarm business. For more information about the nonfarm optional method, see Publication 533.

You cannot combine farming income with nonfarm income from self-employment to figure your net earnings under either of the optional methods.

Using Both Optional Methods

If you use both optional methods, you must add together the net earnings figured under each method to arrive at your total net earnings from self-employment. You can report less than your total actual net earnings from farm and nonfarm self-employment. If you use both optional methods, you cannot report more than $1,600 of your combined net earnings from self-employment.

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