Figuring Net Earnings From Self-Employment for SE Tax

There are two methods for figuring your net earnings from self-employment as a minister, member of a religious order, Christian Science practitioner, or church employee.

• Regular method, or
• Nonfarm optional method.

Regular Method

Most people use the regular method. Under this method, you figure your net earnings from self-employment by totaling your gross income for services you performed as a minister, a member of a religious order who has not taken a vow of poverty, or Christian Science practitioner. Then you subtract your allowable business deductions and multiply the difference by .9235 (92.35%). Use Schedule SE (Form 1040) to figure your net earnings and SE tax.

If you are an employee of a church that elected to exclude you from FICA coverage, figure net earnings by multiplying your church wages shown on Form W-2 by .9235. Do not reduce your wages by any business deductions when making this computation. Use Section B of Schedule SE to figure your net earnings and SE tax.

If you have an approved exemption, or you are automatically exempt, do not include the income or deductions from qualified services in figuring your net earnings from self-employment.

For more information on net earnings from self-employment, get Publication 533.

Gross income. To figure your net earnings from self-employment (on Schedule SE (Form 1040)), include in gross income:

• Salaries and fees for your qualified services (discussed earlier),
• Offerings you receive for marriages, baptisms, funerals, masses, etc.,
• The value of meals and lodging provided to you, your spouse, and your dependents for your employer's convenience,
• The fair rental value of a parsonage provided to you (including the cost of utilities that are furnished) and the rental allowance (including an amount for payment of utilities) paid to you, and
• Any amount a church pays toward your income tax or SE tax, other than withholding the amount from your salary. This amount is also subject to income tax.

For the income tax treatment of these amounts, see Income Tax: Income and Expenses, later.

Example. Pastor Roger Adams receives an annual salary of $16,500 as a full-time minister. The $16,500 includes $1,500 that is designated as a rental allowance to pay utilities. His church owns a parsonage that has a fair rental value of $5,200 per year. Pastor Adams is given the use of the parsonage. He is not exempt from SE tax. He must include $21,700 ($16,500 plus $5,200) when figuring net earnings from self-employment.

The results would be the same if, instead of the use of the parsonage and receipt of the rental allowance for utilities, Pastor Adams had received an annual salary of $21,700 of which $6,700 ($1,500 plus $5,200) per year was designated as a rental allowance.

Overseas duty. Your net earnings from self-employment are determined without any foreign earned income exclusion or the foreign housing exclusion or deduction if you are a U.S. citizen or resident alien who is serving abroad and living in a foreign country.

For information on excluding foreign earned income or the foreign housing amount, get Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.

Example. Paul Jones was the minister of a U.S. church in Mexico. He earned $22,000 and was able to exclude it all for income tax purposes under the foreign earned income exclusion. However, Mr. Jones must include $22,000 when figuring net earnings from self-employment.

Specified U.S. possessions. The exclusion from gross income for amounts derived in Guam, American Samoa, or the Commonwealth of the Northern Mariana Islands does not apply in computing net earnings from self-employment. Also see Residents of Puerto Rico, the Virgin Islands, Guam, the CNMI, and American Samoa, earlier, under U.S. Citizens, Resident and Nonresident Aliens.

Amounts not included in gross income. Do not include the following amounts in gross income when figuring your net earnings from self-employment.

• Offerings that others made to the church.
• Contributions by your church to a tax-sheltered annuity plan set up for you, including any salary reduction contributions, that are not included in your gross income.
• Pension payments or retirement allowances you receive for your past qualified services.
• The rental value of a parsonage or a parsonage allowance provided to you after you retire.

Allowable deductions. When figuring your net earnings from self-employment, deduct all your nonemployee ministerial expenses. Also, deduct all your allowable unreimbursed trade or business expenses that you incur in performing ministerial services as a common-law employee of the church. Include this net amount on line 2 of Schedule SE (Form 1040).

Reimbursement arrangements. If you received an advance, allowance, or reimbursement for your expenses, how you report this amount and your expenses depends on whether the reimbursement was paid to you under an accountable plan or a nonaccountable plan. If you are not sure if you are reimbursed from an accountable plan or a nonaccountable plan, ask your employer.

Accountable plans. To be an accountable plan, your employer's reimbursement arrangement must include all three of the following rules.

1. Your expenses must have a business connection -- that is, you must have paid or incurred deductible expenses while performing services as an employee of your employer.
2. You must adequately account to your employer for these expenses within a reasonable period of time.
3. You must return any excess reimbursement or allowance within a reasonable period of time.

Generally, if your expenses equal your reimbursement, you have no deduction and the reimbursement is not reported on your Form W-2. If your expenses are more than your reimbursement, you can deduct your excess expenses for SE tax and income tax purposes.

Nonaccountable plan. A nonaccountable plan is a reimbursement arrangement that does not meet one or more of the three rules listed under Accountable plans. In addition, even if your employer has an accountable plan, the following payments will be treated as being paid under a nonaccountable plan.

1. Excess reimbursements you fail to return to your employer.
2. Reimbursement of nondeductible expenses related to your employer's business.

Your employer will combine any reimbursement paid to you under a nonaccountable plan with your wages, salary, or other compensation. Your employer will report the combined total in box 1 of your Form W-2. You can deduct your related expenses (for SE and income tax purposes) regardless of whether they are more than, less than, or equal to your reimbursement.

For more information on accountable and nonaccountable plans, get Publication 463, Travel, Entertainment, Gift, and Car Expenses.

Husband and Wife Missionary Team

If a husband and wife are both duly ordained, commissioned, or licensed ministers of a church and have an agreement that each will perform specific services for which they are paid jointly or separately, they must divide the SE income according to the agreement.

If the agreement is with one spouse only and the other spouse is not paid for any specific duties, amounts received for their services are included in only the SE income of the spouse having the agreement.

Maximum Earnings Subject to SE Tax

For 2000, the maximum net earnings from self-employment subject to social security (old age, survivors, and disability insurance) tax is $76,200 minus any wages and tips you earned that were subject to social security tax. The tax rate for the social security part is 12.4%. In addition, all of your net earnings are subject to the Medicare (hospital insurance) part of the SE tax. This tax rate is 2.9%. The combined self-employment tax rate is 15.3%.

Nonfarm Optional Method

You may be able to use the nonfarm optional method for figuring your net earnings from self-employment. In general, the nonfarm optional method is intended to permit continued coverage for social security and Medicare purposes when your income for the tax year is low.

You may use the nonfarm optional method for nonfarm SE income if you meet all of the following tests.

1. Your net nonfarm profits are less than $1,733.
2. Your net nonfarm profits are less than 72.189% of your total gross income from nonfarm self-employment.
3. You are self-employed or a partner on a regular basis. This means that your actual net earnings from self-employment are $400 or more in at least 2 of the 3 tax years before the one for which you use this method.
4. 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 consecutive.

If you meet these four tests, you may report the smaller of two-thirds of the gross income from your nonfarm business, or $1,600 as your net earnings from self-employment.

You may not report less than your actual net earnings from nonfarm self-employment.

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