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 an optional method?   You may want to use the optional methods (discussed later) when you have a loss or a small net 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.)
• You are entitled to the earned income credit. (An optional method may increase your earned income, which could increase your credit.)
• You are entitled to the additional child tax credit. (An optional method may increase your earned income, which could increase your credit.)

Effects of using an optional method.   Using an optional method could increase your SE tax. Paying more SE 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 earnings in gross income, regardless of which method you use to determine SE tax.

Regular Method

Multiply your total earnings subject to SE tax 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

Use the farm optional method only for earnings from a farming business. You can use this method if you meet either of the following tests.

1. Your gross farm income is $2,400 or less.
2. Your net farm profit is less than $1,733.

Figuring farm net earnings.   If you meet either of the two tests explained earlier, use the following table to figure your net earnings from self-employment under the farm optional method.

Gross farm income.   Your gross farm income is the total of the amounts from:

• Line 11, Schedule F (Form 1040), and
• Line 15b, Schedule K-1 (Form 1065), (from farm partnerships).

Net farm profit.   Net farm profit generally is the total of the amounts from:

• Line 36, Schedule F (Form 1040), and
• Line 15a, Schedule K-1 (Form 1065), (from farm partnerships).

However, you may need to adjust the amount reported on Schedule K-1 if you are a general partner or if it is a loss. For more information, see Partnership Income or Loss, earlier.

Table15-1. Figuring Farm Net Earnings

IF your gross farm income is ...	THEN your net earnings are equal to...
$2,400 or less	two-thirds of your gross farm income.
more than $2,400	the greater of: $1,600, or Actual net earnings. *

^* If actual net earnings are greater, you cannot use the farm optional method.

Social security credits.   Since two-thirds of $2,400 is $1,600, this counts for one credit ($1,600 ÷ $870) for social security coverage in 2002. 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.

You could lose coverage for disability if your earnings are not sufficient over time to maintain that coverage.

Optional earnings less than actual earnings.   If your gross farm income is $2,400 or less and your farm net earnings 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.

Two or more farms.   If you operate 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 earnings subject to SE tax. 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 earnings subject to SE tax under the farm optional method are $1,000 (2/3 × $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 earnings subject to SE tax from your nonfarm business. You can use this method even if you do not use the farm optional method for determining your earnings subject to SE tax 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 earnings subject to SE tax 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.

Reporting Self-Employment Tax

Use Schedule SE (Form 1040) to figure and report your SE tax. Then enter the SE tax on line 56 of Form 1040 and attach Schedule SE to Form 1040.

If you have to pay SE tax, you must file Form 1040 (with Schedule SE attached) even if you do not otherwise have to file a federal income tax return.

Self-employment tax deduction.   You can deduct half of your SE tax in figuring your adjusted gross income. This deduction only affects your income tax. It does not affect either your net earnings from self-employment or your SE tax.

To deduct the tax, enter on Form 1040, line 29, the amount shown on the Deduction for one-half of self-employment tax line of the Schedule SE.

Long Schedule SE.   Most taxpayers can use Section A-Short Schedule SE to figure their SE tax. However, the following taxpayers must use Section B-Long Schedule SE.

• Individuals whose total wages and tips subject to social security or railroad retirement tax plus earnings subject to SE tax are more than $84,900.
• Ministers, members of religious orders, and Christian Science practitioners not taxed on earnings from these sources (with IRS approval) who owe SE tax on other earnings.
• Employees who earned wages reported on Form W-2 of $108.28 or more working for churches or church organizations that elected an exemption from employer social security and Medicare taxes.
• Individuals with tip income subject to social security or Medicare taxes that was not reported to their employers.
• Individuals who use one of the optional methods to figure earnings subject to SE tax.

Joint return.   If you file a joint return, you cannot file a joint Schedule SE. This is true whether one spouse or both spouses have earnings subject to SE tax. Your spouse is not considered self-employed just because you are. If both of you have earnings subject to SE tax, each of you must complete a separate Schedule SE. However, if one spouse uses the Short Schedule SE and the other spouse has to use the Long Schedule SE, both can use the same form. Attach both schedules to the joint return. If you and your spouse operate a business as a partnership, see Husband and wife partners, earlier, under Who Must Pay Self-Employment Tax.

Community income.   If any of the income from a farm or business, other than a partnership, is community income under state law, it is included in the earnings subject to SE tax of the spouse carrying on the trade or business. The identity of the spouse carrying on the trade or business is determined by the facts in each case.

Community income from a partnership.   If you are a partner and your distributive share of any income or loss from a trade or business carried on by the partnership is community income, treat your share as your earnings subject to SE tax. Do not treat any of your share as earnings of your spouse.

Employment Taxes

Important Change for 2003

Wage limit for social security tax.   The wage limit on wages subject to the social security tax for 2003 will be published in Publication 51, Circular A, Agricultural Employer's Tax Guide. There is no limit on wages subject to the Medicare tax.

Important Reminder

Electronic deposits of taxes.   You must use the Electronic Federal Tax Payment System (EFTPS) to make electronic deposits of all depository tax liabilities you incur in 2003 and thereafter if you deposited more than $200,000 in federal depository taxes in 2001 or you had to use EFTPS in 2002.

See Electronic Federal Tax Payment System (EFTPS) under Reporting and Paying Social Security, Medicare, and Withheld Income Taxes.

Introduction

You are generally required to withhold federal income tax from the wages of your employees. You may also be subject to social security and Medicare taxes under the Federal Insurance Contributions Act (FICA) and federal unemployment tax under the Federal Unemployment Tax Act (FUTA). This chapter includes information about these taxes.

You must also pay self-employment tax on your earnings from farming. See chapter 15 for information on self-employment tax.

Topics

This chapter discusses:

• Farm employment
• Family employees
• Crew leaders
• Social security and Medicare taxes
• Income tax withholding
• Advance payment of the earned income credit
• Reporting and paying social security, Medicare, and withheld income taxes
• Federal unemployment (FUTA) tax

Useful Items You may want to see:

Publication

• 15   Circular E, Employer's Tax Guide
• 15-A   Employer's Supplemental Tax Guide
• 15-B   Employer's Tax Guide to Fringe Benefits
• 51   Circular A, Agricultural Employer's Tax Guide

Form (and Instructions)

• W-2   Wage and Tax Statement
• W-4   Employee's Withholding Allowance Certificate
• W-5   Earned Income Credit Advance Payment Certificate
• W-9   Request for Taxpayer Identification Number and Certification
• 940 (or 940-EZ)   Employer's Annual Federal Unemployment (FUTA) Tax Return
• 943   Employer's Annual Tax Return for Agricultural Employees
• 8109   Federal Tax Deposit Coupon

See chapter 21 for information about getting publications and forms.

Farm Employment

In general, you are an employer of farm workers if your employees do any of the following types of work.

• Raising or harvesting agricultural or horticultural products on a farm.
• Operating, managing, conserving, improving, or maintaining your farm and its tools and equipment.
• Handling, processing, or packaging any agricultural or horticultural commodity if you produced more than half of the commodity.
• Work related to cotton ginning, turpentine, or gum resin products.
• Housework in your private home on a farm operated for profit. (You may report the taxes for household employees separately. See Publication 926, Household Employer's Tax Guide.)

For more information, see Publication 51.

Workers are generally your employees if they perform services subject to your control. You are not required to withhold or pay employment taxes for independent contractors who are not your employees. For more information, see Publication 15-A, Employer's Supplemental Tax Guide.

If you employ a family of workers, each worker subject to your control (not just the head of the family) is an employee.

Special rules apply to crew leaders. See Crew Leaders, later.

Employer identification number (EIN).   If you have employees, you must have an EIN. If you do not have an EIN, request one on Form SS-4, Application for Employer Identification Number. The instructions for Form SS-4 provide information on how to apply for an EIN by telephone, fax, or mail. Form SS-4 is available from either the IRS or the Social Security Administration (SSA). See chapter 21 for information about ordering this form.

Employee's social security number (SSN).   An employee who does not have an SSN should submit Form SS-5, Application for a Social Security Card, to the SSA. Form SS-5 is available from any SSA office or by calling 1-800- 772-1213. It is also available from the SSA's Internet web site at www.ssa.gov.

The employee must furnish evidence of age, identity, and U.S. citizenship with the Form SS-5. An employee who is 18 or older must appear in person with this evidence at an SSA office.

INS Form I-9.   You must verify that each new employee is legally eligible to work in the United States. This includes completing the Immigration and Naturalization Service (INS) Form I-9, Employment Eligibility Verification. Form I-9 is available from INS offices or by calling 1-800-870-3676. It is also available from the INS' Internet web site at www.ins.gov. You can contact the INS at 1-800-375-5283 or 1-800-357-2099 for more information.

New hire reporting.   You are required to report any new employee to a designated state new hire registry. Many states accept a copy of Form W-4 with employer information added. Call the Office of Child Support Enforcement at 202-401-9267 or visit its web site at www.acf.dhhs.gov/programs/cse/newhire for more information.

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