There are three ways to figure your net earnings from
self-employment.
- The regular method.
- The nonfarm optional method.
- The farm optional method.
Which Method Should You Use?
You must use the regular method unless you are eligible to use one
or both of the optional methods. See Table 4. Can I Use the
Optional Methods?
Why use an optional method?
You can generally use the optional methods (discussed later) when
you have a loss or a small amount of net income from self-employment
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 will increase your earned
income, which could increase your credit.)
- You are entitled to the earned income credit. (An optional
method will increase your earned income, which could increase your
credit.)
Table 4. Can I Use the Optional Methods?
Effects of using an optional method.
Using an optional method could increase your self-employment tax.
Paying more self-employment tax can 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 may be used only to figure your SE tax. To
figure your income tax, include your actual SE income in gross income,
regardless of which method you use to determine SE tax.
Regular Method
Multiply your net SE income 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.
You must use the regular method unless you are eligible to use one
or both of the optional methods.
Nonfarm Optional Method
Use the nonfarm optional method only for SE income that does not
come from farming. You may use this method if you meet all the
following tests.
- 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 profit is:
- Less than $1,733, and
- Less than 72.189% of your gross nonfarm income.
You can find your net nonfarm profit on:
Optional net earnings less than actual earnings.
You cannot use this method to report an amount less than your
actual net earnings from self-employment. Your actual net earnings are
your net earnings figured using the regular method, explained earlier.
Figuring Nonfarm Net Earnings
If you meet the three tests explained earlier, use the following
table to figure your net earnings from self-employment under the
nonfarm optional method.
Table 3. Figuring Non-Farm Net Earnings
Gross income of $2,400 or less.
The following examples illustrate how to figure net earnings when
gross income from all nonfarm trades or businesses is $2,400 or less.
Example 1--net nonfarm profit less than $1,733 and less
than 72.189% of gross nonfarm income.
Ann Green had actual net earnings from self-employment of $800 in
1998 and $900 in 1999 from her craft business. She meets the test for
being self-employed on a regular basis. Her gross income and net
profit in 2000 are as follows:
| Gross income |
$2,100 |
| Net profit |
$1,200 |
Because her net profit is less than $1,733 and less than 72.189% of
her gross nonfarm income, Ann can use her nonfarm optional method net
earnings of $1,400 ( 2/3 x $2,100).
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 nonfarm income.
Example 3--net loss from a nonfarm business.
Assume that in Example 1 Ann has a net loss of $700. In
this situation, she can use $1,400 ( 2/3 x $2,100)
as her net earnings under the nonfarm optional method.
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.
The following examples illustrate how to figure net earnings when
gross income from all nonfarm trades or businesses is 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 $8,500 in 1997, $10,500 in 1998, and $9,500
in 1999. He meets the test for being self-employed on a regular basis.
His gross income and net profit in 2000 are as follows:
| Gross income |
$12,000 |
| Net profit |
$1,200 |
Because his net profit is less than $1,733 and less than 72.189% of
his gross nonfarm income, John may use $1,600 as his net earnings.
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.
Farm Optional Method
If you are in the farming business, either as a sole proprietor or
as a partner, you may be able to use the farm optional method to
figure your net earnings from farm self-employment.
Figuring Farm Net Earnings
Use Table 5 to determine what you may report as your net
earnings from self-employment under the farm optional method.
Table 5. Net Earnings from Farming
Optional earnings less than actual earnings.
If your net earnings under the farm optional method 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.
Gross income from farming.
Farming income includes what you receive from cultivating the soil
or raising or harvesting any agricultural commodities. It also
includes income from the operation of a livestock, dairy, poultry,
bee, fish, fruit, or truck farm, or plantation, ranch, nursery, range,
orchard, or oyster bed. This includes income in the form of crop
shares if you materially participate in production or management of
production.
Government commodity program payments.
If you receive government commodity program payments on land you
rent out, do not include these payments unless you meet the material
participation test. For more information on material participation,
see chapter 15 in Publication 225.
Gross income from a farm sole proprietorship.
If you operate your farm as a sole proprietorship, use the
following table to determine your gross farm income.
Table 6. Gross Farm Sole Proprietorship
Determining gross income from a farm partnership.
If you are a member of a farm partnership, your gross income
includes your distributive share of the partnership's gross income
from farming. The partnership must follow the steps in Table 7
to determine your distributive share of gross farm income.
Table 7. Gross Partnership Farm Income
The result determined in (3) above is your distributive share of
the partnership's gross income from farming. Use this distributive
share of gross income, any guaranteed payments (discussed next), and
any other gross income from farming to determine whether you can use
the farm optional method to figure your net earnings from
self-employment.
Guaranteed payments.
Any guaranteed payments you receive from a farm partnership that
are determined without regard to partnership income are gross income
from your farming business (not the partnership's). Use the total of
these guaranteed payments, your distributive share of gross income
from a farm partnership, and any other gross income you receive from
farming to determine whether you can use the farm optional method to
figure your net earnings from self-employment.
Using Both Optional Methods
If you have self-employment income from both farming and nonfarming
businesses, you may be able to use both optional methods to determine
your net earnings from self-employment.
To figure your net earnings using both optional methods, you must:
- Separately figure your earnings from farming and nonfarming
under each method. Do not combine farming income with
nonfarm income 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.
You can report less than your total actual net earnings from
farm and nonfarm self-employment but not less than actual net earnings
from nonfarm self-employment. If you use both optional methods, you
can report no more than $1,600 as your combined net earnings from
self-employment.
Example 1.
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 8. Farm and Nonfarm Earnings -- Example 1.
You can figure your net earnings from self-employment in any of the
four combinations shown below:
Table 9. Net earnings--Example 1.
Example 2.
Assume that in Example 1 your gross income, actual net
earnings from self-employment, and 2/3 of your gross
income from self-employment are as follows:
Table 10. Farm and Nonfarm Earnings--Example 2.
Your net earnings from self-employment may be either of the amounts
figured below:
Table 11. Net Earnings--Example 2.
You can not use the nonfarm optional method for the year because
your actual net earnings from nonfarm self-employment ($800) are not
less than 72.189% of gross nonfarm income (.72189 x $1,000 =
$721.89).
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