Next Page: 533-Reporting Self-Employment Tax
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to find additional instances of index items.Net earnings, methods for figuring
Methods for Figuring
Net Earnings
- The regular method.
- The nonfarm optional method.
- The farm optional method.
Which Method Should You Use?
Why use an optional method?
- 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.)
Effects of using an optional method.
How to figure net earnings:
How to figure net earnings: Regular method
Regular method
Regular Method
Nonfarm optional method
Optional method:
Optional method: Nonfarm
Nonfarm Optional Method
- You are self-employed on a regular basis. This means that your actual net earnings from self-employment were $400 or more in at least 2 of the 3 tax years before the one for which you use this method. The net earnings can be from either farm or nonfarm earnings or both.
- 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 one after another.
- Your net nonfarm profits were:
- Less than $1,733, and
- Less than 72.189% of your gross nonfarm income.
Net nonfarm profits.
- Line 31, Schedule C (Form 1040),
- Line 3, Schedule C–EZ (Form 1040),
- Line 15a, Schedule K–1 (Form 1065), (from nonfarm partnerships), and
- Box 9, Schedule K–1 (Form 1065–B), (look for code K1).
Gross nonfarm income.
- Line 7, Schedule C (Form 1040),
- Line 1, Schedule C–EZ (Form 1040),
- Line 15c, Schedule K–1 (Form 1065), (from nonfarm partnerships), and
- Box 9, Schedule K–1 (Form 1065–B), (look for code K2).
Figuring Nonfarm Net Earnings
|
| |
| If your gross nonfarm income is ... | Then your net earnings are equal to ... |
| $2,400 or less | The greater of:
|
| More than $2,400 | The greater of:
|
Optional earnings less than actual earnings.
Gross income of $2,400 or less.
Example 1—net nonfarm profit less than $1,733 and less than 72.189% of gross nonfarm income. Ann Green runs a craft business. Her actual net earnings from self-employment were $800 in 1999 and $900 in 2000. She meets the test for being self-employed on a regular basis. She has not previously used the nonfarm optional method for more than 4 years. Her gross income and net profit in 2001 are as follows:
| Gross income | $2,100 |
| Net profit | $1,200 |
Ann's actual net earnings for 2001 are $1,108 ($1,200 x .9235). Because her net profit is less than $1,733 and less than 72.189% of her gross income, she can use the nonfarm optional method to figure net earnings of $1,400 (2/3 x $2,100). Because these net earnings are higher than her actual net earnings, she can report net earnings of $1,400 for 2001.
Example 2—net nonfarm profit less than $1,733 but not less than 72.189% of gross nonfarm income. Assume that in Example 1 Ann's gross income is $1,000 and her net profit is $800. She must use the regular method to figure her net earnings. She cannot use the nonfarm optional method because her net profit is not less than 72.189% of her gross income.
Example 3—net loss from a nonfarm business. Assume that in Example 1 Ann has a net loss of $700. She can use the nonfarm optional method and report $1,400 (2/3 x $2,100) as her net earnings.
Example 4—net earnings less than $400. Assume that in Example 1 Ann has gross income of $525 and a net profit of $175. In this situation, she would not pay any SE tax under either the regular method or the nonfarm optional method because her net earnings under both methods are less than $400.
Gross income of more than $2,400.
Example 1—net nonfarm profit less than $1,733 and less than 72.189% of gross nonfarm income. John White runs an appliance repair shop. His actual net earnings from self-employment were $10,500 in 1999 and $9,500 in 2000. He meets the test for being self-employed on a regular basis. He has not previously used the nonfarm optional method for more than 4 years. His gross income and net profit in 2001 are as follows:
| Gross income | $12,000 |
| Net profit | $1,200 |
John's actual net earnings for 2001 are $1,108 ($1,200 x .9235). Because his net profit is less than $1,733 and less than 72.189% of his gross income, he can use the nonfarm optional method to figure net earnings of $1,600. Because these net earnings are higher than his actual net earnings, he can report net earnings of $1,600 for 2001.
Example 2—net nonfarm profit not less than $1,733. Assume that in Example 1 John's net profit is $1,800. He must use the regular method. He cannot use the nonfarm optional method because his net nonfarm profit is not less than $1,733.
Example 3—net loss from a nonfarm business. Assume that in Example 1 John has a net loss of $700. He can use the nonfarm optional method and report $1,600 as his net earnings from self-employment.
How to figure net earnings: Farm optional method
Optional method: Farm
Using the farm optional method
Farm Optional Method
- Your gross farm income is $2,400 or less.
- Your net farm profits are less than $1,733.
Gross farm income.
- Line 11, Schedule F (Form 1040), and
- Line 15b, Schedule K–1 (Form 1065), (from farm partnerships).
Net farm profits.
- Line 36, Schedule F (Form 1040), and
- Line 15a, Schedule K–1 (Form 1065), (from farm partnerships).
Figuring Farm Net Earnings
Optional earnings less than actual earnings.
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 less than $400.
Using Both Optional Methods
- Figure your farm and nonfarm earnings separately under each method. Do not combine farm earnings with nonfarm earnings to figure your net earnings under either method.
- Add the net earnings figured under each method to arrive at your total net earnings from self-employment.
Example. You are a self-employed farmer. You also operate a retail grocery store. Your gross income, actual net earnings from self-employment, and optional farm and optional nonfarm net earnings from self-employment are as follows:
Table 6. Example — Farm and Nonfarm Earnings
You can figure your net earnings from self-employment in any of the four combinations shown below:
Table 7. Example — Net Earnings
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