2010 Sch. SE & the Small Business Jobs Act of 2010

[ubermax]

the instructions for line 3 of the '10 SE are somewhat clear " you can reduce your net self-employment income by the amount of your self-employed health insurance deduction" which it goes on to say is found on line 29 of Form 1040;seems to me that line 3 is actually reducing Schedule C income.

Sec. 2042 of SBJA titled "Deduction for Health Insurance Costs in Computing Self-Employment Taxes in 2010" points to an amendment to Paragraph 4 of IRC Section 162(l) ; the amended wording is " the deduction allowable by reason of this subsection shall not be taken into account in determining an individual's net earnings from self-employment ( within the meaning of section 1402(a) ) for purposes of chapter 2 for taxable years beginning before January 1, 2010, or after December 31, 2010" ; implying that for 2010 it shall be taken into account.

practitioners would follow the line by line mechanics of Schedule SE ; but to me the words shall be taken into account are fuzzy .

I just think the wording in both the 2010 Schedule SE instructions and 162(l) are not precise enough - anyone agree ? disagree ?

I'd also be interested in knowing if there were unpublished discussions with IRS or other cites that clarified this ??

thanks , in advance, to those who respond .

[masteff]

Going back to 1987, following the major tax reform of TRA '86, only 25% of SE health insurance was allowed on the front of the 1040, the remainder had to go on schedule A.

As for allowing it for SE tax in 2010, sometimes we can find evidence of Congress' legislative intent. In this case we can look at SBJA '10 itself... Section 2042 is entitled: "SEC. 2042. DEDUCTION FOR HEALTH INSURANCE COSTS IN COMPUTING SELF-EMPLOYMENT TAXES IN 2010." I'm sure there are other sources of legislative intent as well.

Then there's these pages on the IRS website:

http://www.irs.gov/businesses/small/articl...07,00.html#2042

http://www.irs.gov/newsroom/article/0,,id=233824,00.html

[ubermax]

Going back to 1987, following the major tax reform of TRA '86, only 25% of SE health insurance was allowed on the front of the 1040, the remainder had to go on schedule A.

As for allowing it for SE tax in 2010, sometimes we can find evidence of Congress' legislative intent. In this case we can look at SBJA '10 itself... Section 2042 is entitled: "SEC. 2042. DEDUCTION FOR HEALTH INSURANCE COSTS IN COMPUTING SELF-EMPLOYMENT TAXES IN 2010." I'm sure there are other sources of legislative intent as well.

Then there's these pages on the IRS website:

http://www.irs.gov/businesses/small/articl...07,00.html#2042

http://www.irs.gov/newsroom/article/0,,id=233824,00.html

these are good sites ; I guess I just thought NESE was what you got after multiplying the amount brought over from Schedule C by .9235 ;but line 3 of the 2010 Schedule SE is reducing that Schedule C amount not NESE - what am I missing here ?

[masteff]

Multiplying by .9235 is to adjust for the deduction for 1/2 of SE taxes in accordance with 1402(a)(12). So you have to take all your income and deductions before you take that step.

So it is "taken into account in determining an individual's net earnings from self-employment". It's just before the SE tax adjustment, not after it.

[ubermax]

Multiplying by .9235 is to adjust for the deduction for 1/2 of SE taxes in accordance with 1402(a)(12). So you have to take all your income and deductions before you take that step.

So it is "taken into account in determining an individual's net earnings from self-employment". It's just before the SE tax adjustment, not after it.

so for the Sch. SE instructions Line 3 to be accurate , Line 2 must be known as NESE ? - I thought it was Sch. C profit - also in trying to draw a parallel between SE tax and its' counterpart for a W-2 employee , the W-2 employee's portion of OASDI & Medicare is 7.65% of gross salary whereas for the self-employed we're first reducing Sch. C net profit by 7.65% and then determining the self-employment tax - and of course for 2010 there was also the line 29 self-employed health insurance deduction.

I can understand the self-employed getting the income tax break by providng that 1/2 SE deduction but it seems like they're paying a smaller SE Tax compared to the W-2 employee ?

[mwyatt]

My understanding from last year was that one should ignore the tinkering with one-time Health Insurance deductions in determining Net Earned Income for 2010 (i.e., your deduction should NOT match what is actually shown on the 1040 if the Health Insurance deduction is in play). See:

Relius Technical Update

[ubermax]

My understanding from last year was that one should ignore the tinkering with one-time Health Insurance deductions in determining Net Earned Income for 2010 (i.e., your deduction should NOT match what is actually shown on the 1040 if the Health Insurance deduction is in play). See:

Relius Technical Update

correct and Pub. 560 does mention that SEHI is to be ignored when calculating 1/2 the self employment tax ; my confusion is explaining that .9235 factor used on Sch. SE in the context of the particular Code sections , i.e why isn't SETax based on the net profit number brought over from the C ?

[mwyatt]

Let's remember what the whole purpose of the deduction is for: the "employer" side (not the employee side) of FICA taxes paid.

Contrast a sole employee getting paid $100,000 (his first and last check for the year on 12/31); this needs to be divided up between his gross wages and the Employer FICA contribution.

Now mathematically

So, W-2 would be $100,000/ (1+.0765) = 92,893.64, with Employer FICA of 7.65% of that ($7,106.36) to total $100,000 available.

The math isn't exact, but (1-.0765 = .9235) is their way of adjusting for the Employer FICA portion.

[ubermax]

Let's remember what the whole purpose of the deduction is for: the "employer" side (not the employee side) of FICA taxes paid.

Contrast a sole employee getting paid $100,000 (his first and last check for the year on 12/31); this needs to be divided up between his gross wages and the Employer FICA contribution.

Now mathematically

So, W-2 would be $100,000/ (1+.0765) = 92,893.64, with Employer FICA of 7.65% of that ($7,106.36) to total $100,000 available.

The math isn't exact, but (1-.0765 = .9235) is their way of adjusting for the Employer FICA portion.

right now if I'm a w-2 ee making 100k , my FICA=His FICA= $7,650 - to me that calculation should be the same for the sole prop , i.e. .0765 X Sch. C with an additional benefit for the sole prop in that he gets to deduct it on line 27; but the .9235 is on that SE & we have to accept it but it still doesn't make sense to me ; to me you probably get to that .9235 with reasoning that isn't hitting me yet :angry:

[masteff]

Code Section 1402(a) is entitled "Net earnings from self-employment" and within that section we're told "that in computing such gross income and deductions":

"(12) in lieu of the deduction provided by section 164 (f) (relating to deduction for one-half of self-employment taxes), there shall be allowed a deduction equal to the product of—

(A) the taxpayer’s net earnings from self-employment for the taxable year (determined without regard to this paragraph), and

(B) one-half of the sum of the rates imposed by subsections (a) and (b) of section 1401 for such year;"

Looking at that, we see that we take NESE-before-this-deduction (ie Line 3 of Schedule SE) and mulitply it by 1/2 of the SE tax rates (ie, 1/2 of .153, or .0765). As mwyatt notes, this is accomplished on Line 4 of Schedule SE by multiplying Line 3 by (1-.0765) or .9235

Thus, I would conclude that in the strict sense of 1402(a), Line 4 is NESE.

Just imagine the mess of applying the wage base to the reduction in Line 4. That "in lieu of" that Congress wrote into 1402(a)(12) simplifies a potentially messy calc.

[ubermax]

Code Section 1402(a) is entitled "Net earnings from self-employment" and within that section we're told "that in computing such gross income and deductions":

"(12) in lieu of the deduction provided by section 164 (f) (relating to deduction for one-half of self-employment taxes), there shall be allowed a deduction equal to the product of—

(A) the taxpayer’s net earnings from self-employment for the taxable year (determined without regard to this paragraph), and

(B) one-half of the sum of the rates imposed by subsections (a) and (b) of section 1401 for such year;"

Looking at that, we see that we take NESE-before-this-deduction (ie Line 3 of Schedule SE) and mulitply it by 1/2 of the SE tax rates (ie, 1/2 of .153, or .0765). As mwyatt notes, this is accomplished on Line 4 of Schedule SE by multiplying Line 3 by (1-.0765) or .9235

Thus, I would conclude that in the strict sense of 1402(a), Line 4 is NESE.

Just imagine the mess of applying the wage base to the reduction in Line 4. That "in lieu of" that Congress wrote into 1402(a)(12) simplifies a potentially messy calc.

totally agree and the OP should probably have been titled "SE Tax Question" ----- Code says the deduction, i.e. line 27 is (Sch.C net profit)(1-.0765)(.0765) ; again ,my curiosity is the IRS use of that middle factor, (1-.0765) - what is the intent or reason of applying that factor ?

[masteff]

If you were a corporation instead of a sole prop, you'd get to deduct the EMPLOYER portion of the FICA tax on your own pay. That (1-.0765) factor is to compensate for that. And it comes from Code Section 1402(a)(12).

Actually 1402(a)(12) is just the (-.0765) part of it. The IRS, to simplify Schedule SE, did a minor shortcut to accomplish the deduction in one step rather than two steps.

We could change Schedule SE to look more like the Code if we did this:

Line 3: Line 1 + Line 2

Line 4a: Line 3 times .0765 (this is the 1402(a)(12) deduction)

Line 4b: Line 3 minus Line 4a

Line 5: SE Tax on Line 4b

If we call Line 3 "X", it's the same to say either (X-.0765X) or X(1-.0765)

So first we have Congress using a shortcut in 1402(a)(12) (in lieu of the actual 1/2 SE tax) and then the IRS using a shortcut to save a line (possibly because people were making a mess of the calc or carrying the wrong line to their 1040).

EDIT:

Going back to my first sentence in this post, the (-.0765) isn't about the SE tax, it's about arriving at an equitable calculation of the net income of the trade or business. It really is that a separate business entity (ie a corporation) would get a deduction on the ER portion of SE tax on the owner's pay. And the sole prop does get that deduction, it's just on the face of the 1040 rather than on the Schedule C. So to be equitable, in calculating the SE tax on income from a trade or business, they use the (1-.0765) to compensate for that.

[ubermax]

it seems like the intent of the rules is to structure it so that sole props get the same tax treatment as the C-corp wrt the FICA taxes ; suppose I'm a C-corp and take a salary of $100,000 and remit $15,300 to cover my FICA obligation but only claim a salary expense of $92,350 when I file ; and then I pretend I'm a sole prop and take $7,650 on line 27 and pay $15,300 per line 56 - similar treatment .

but to me that's not what's happening here with the way Sch SE is designed - I take $100,000(.9235)(.0765) or $7,064.78 as a deduction on line 27 & remit $100,000(.9235)(.153) or $14,129.55 via line 56 to cover FICA .