It's Just A Wafer-Thin Mint

So, tax season seems to be starting a tad early this year.

I held a seminar last weekend for about 23 people, and have another scheduled for the 19th. I won't start taking appointments for doing returns until the end of the month, but I currently have a list of about a dozen people who have contacted me for slots. I've agreed to do someone's tax return this weekend, because they'll be out of town when the VITA site is open in March and April. And of course, my own return was mailed out last week.

I've started getting emails from people with questions. Here's a typical one:

One more question--what does a "$400 profit" mean exactly? That I only have to figure out the self-employment tax if line 24 is $400+?

(This was in a follow-up to a preceding question about filing as a Qualified Performing Artist, and how to deal with self employment income.)

And here's the response I sent back this afternoon:

When you file a Schedule C or C-EZ to track self employment income
& expenses, if the amount of profit is more than about $425, then you
would be obligated to pay "self employment tax" on the additional
amount above $425. The amount of self employment tax you owe is
calculated on Form SE, and then gets carried over to line 58 of the
1040 form.

What's happening here is that you are making a contribution into the
Social Security Trust Fund. For example, when you work a regular job,
you and your employer split your Social Security contribution 50/50.
In this case, since you are in effect your own employee, you're
responsible for paying into the Fund on your own behalf, hence the
tax. On the plus side, if you do have to pay self employment tax, you
get to take a credit of half the amount as an adjustment to your
income on line 27 of the 1040; this doesn't do much to reduce your
overall tax burden, but it does reduce your Adjusted Gross Income
(AGI) slightly, which helps a bit (the idea being that the IRS isn't
going to tax money you're already paying as a tax in the first place).

Calculating expenses can get a bit tricky at this point, because if
you have self employment income, you want to use as much of your
qualifying expenses as possible to reduce the net income (profit from
the business) to below the $425 mark in order to avoid paying the self
employment tax, but still ideally show just a small amount of profit
of anywhere between +$1 and +$400. That way, the IRS sees you're
running a profitable business, which they really, really like, but at
the same time you're not being dinged for the extra tax.

The other tricky part, is that some of your expenses can only be
applied directly against the income that caused you to spend the money
in the first place; union working dues would be a good example. So,
if you have both 1099 and W-2 income, some of your expenses would need
to be applied exclusively against each particular income source, while
some things - basically anything you spend seeking work, as opposed to
what you spend because you HAVE work - can be written off 100% against
your self employment income.

If you have a lot of expenses, but not much 1099 income, you're going
to be in good shape, because as a QPA you're not obligated to report
all your "job seeking" expenses on the Schedule C. Just put down
enough to get below $425 profit, and then you can pile all the rest of
it onto line 24. On the other hand, if the situation is reversed and
you have much more 1099 income than you have expenses to offset
against it, there's probably no way you're going to avoid paying some
self employment tax.

The upshot is that if you have income from both 1099 & W-2, the amount
of expense you can take on line 24 as a QPA gets knocked down, since
at least some of it HAS to be applied against your Schedule C income.
On the other hand, if all you have is W-2 income, then it's not an
issue and all of your expenses can go on line 24. The real advantage
to the QPA is that you don't have to worry about itemizing your
expenses on a Schedule A, which is subject to the "2% limit" (you
don't get credit for the first 2% of expenses as a ratio of net
income), and it means you don't have to worry about digging up enough
expenses to exceed the Standard Deduction - it all gets counted, which
results in a lower AGI, and thus a smaller tax obligation (and
conversely, a larger refund - woo hoo!).

Also, make note that net income from self employment is entered on
line 12 of the 1040, whereas income you receive on a W-2 would be
entered on line 7, then both get added together on line 22. Any
remaining QPA expenses are entered on line 24, and the 50% of the self
employment tax - if any - is entered on line 27, both of which are
then subtracted from your income, and the remainder is entered on line
37/38 as your Adjusted Gross Income.

So, the basic formula is:

W-2 income (line 7) + 1099 net income (line 12) - QPA expenses (line
24) - 50% of any self employment tax (line 27) = AGI (line 37).

I realize this is all rather confusing, but again just keep in mind
that, so long as you meet the three tests for the QPA, you're going to
be able to take advantage of all your expenses; it's just a matter of
figuring out where to apply them.

This evening, I received a "thank you" email, along with one more quesiton:

How do you manage to keep track of all that without having your head explode?

How indeed.

Heh.

I think there's simply no question about it any longer.

I've become a tax-geek.