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Self-Employment 400-28-65-10-35

(Revised 04/01/14 ML #3401)

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IM 5229

AMENDED IM 5192

 

 

NDAC 75-02-01.3-07

 

 

Self-Employment 400-28-65-10-35

An individual who is working for themselves, rather than for an employer, is considered self-employed. The individual may be a contractor, franchise holder, owner/operator, partner, etc. The individual must meet the following criteria to be considered self-employed:

1. Earn the income directly from business or trade, not from wages or salary from an employer.

 

2. Be responsible for the payment of entire Social Security and Federal withholding taxes. [If an employee, the employer would pay half of their Social Security Tax and withhold federal income tax from the employee’s salary.]

 

3. File self-employment tax forms, however, not all individuals file tax forms. In these special circumstances, income must be anticipated.

 

Calculating Self-Employment Income

Self-employment income is normally calculated by completing the EAP Self-Employment Worksheet using data from tax forms as verification.

Information for each business must be calculated separately. When a

household has filed self-employment income taxes the income is

determined as follows:

  • If the income represents a household's annual income, the income must be annualized over a 12-month period of time, even if the income is received within a shorter period of time during those 12 months.

  • If a self-employment enterprise has been in existence for less than a year and continues to operate, the income must be averaged over the period of time the business has been in operation.

  • If an individual is self-employed for only part of the year to supplement their income from regular employment, the self-employment income must be averaged over the period of time it is intended to cover rather than a 12-month period.

 

Example:

An individual may be a self-employed painter during the three summer months and works as a housekeeper for regular wages the rest of the year. The self-employment income from painting is averaged over the three summer months because it is intended to meet the individual's needs for only part of the year.

 

When the total business 'profit' as calculated above results in a loss:

  • Zero income will be used. A loss from a self-employment business cannot be used to offset or reduce income from other self-employment or other sources such as earned income.

 

Anticipating Self-Employment Income in Special Circumstances

When a household has not filed a self-employment income tax return or there has been a significant increase or decrease in the operation of the business, income tax forms, monthly ledgers or bookkeeping records may be used as verification. The income is determined as follows:

1. Business Not In Operation a Complete Calendar Year or Tax Forms Not Filed

  1. The applicant will need to provide monthly income and expense ledgers to anticipate self-employment income and unearned income as a result of self-employment. The EAP Anticipated Self-Employment Worksheet will assist with determining the monthly net farming and business income.

 

2. Partial Liquidation of Business

  1. If a business sells some land, equipment, or other capital items to obtain money for current operating expenses and/or pay off a loan, and does not expect a substantial reduction in self-employment income as a result of the sale, continue to look at the most recent income tax forms.

 

  1. If the business liquidates a large enough portion of the business to result in an anticipated substantial reduction in the self-employment income, the income tax forms must be appropriately adjusted to accurately anticipate the current year's income using the most recent income tax forms. Income and expenses (other than depreciation and depletion) for the portion of the business that is not being liquidated is used to determine net self employment income.

 

Capital gains/losses on sale of property are counted as income.

 

NOTE: Use only the income or loss from the sale of capital items that can be reasonably anticipated to recur during the current year.

 

  1. If the business expects to liquidate partially but has not done so yet, use the most recent income tax forms in their entirety until the liquidation takes place.

 

3. Significant Increase or Decrease in Operation

A farm or business may have a significant increase or decrease in operation that is temporary and does not result in liquidation of the business. In these cases, one of the following methods must be used:

 

  1. If the applicant has had an estimated tax return prepared for the current business year, use the estimated tax return forms to complete the EAP Self-Employment Worksheet.

 

  1. If the applicant has prepared documents (such as farm plans) from a lender or bank or monthly income and expense ledgers, these documents may be used to arrive at the current year’s anticipated income and expenses. The EAP Anticipated Self-Employment Worksheet will assist with determining the monthly net farming and business income. Anticipated capital gains/losses on sale of property are counted as income.

 

4. Termination Of Business

  1. If a business expects to completely liquidate but has not done so yet, continue to use the most recent income tax forms or one of the methods described in #3 above until the business has liquidated.

 

  1. If a business has been completely liquidated, tax forms cannot be used to evaluate the applicant's income. Use only whatever income is currently available from other sources.

 

Treatment of Self-Employment Income

When an individual is actively engaged in a self-employment business, the income they receive is considered earned income. The following types of income are always considered earned income:

• Capital or Ordinary Gains/Losses

• Farm Income

• Business Income

• Partnership – Ordinary income, guaranteed payments to partners, depreciation and depletion

 

However, there are some types of income included on the self-employment income tax forms that are considered unearned income. The following types of income are always considered unearned income:

• Royalty income

• Cooperative distributions (patronage dividends)

• Partnership – rental, interest and dividend income

• Income from S-Corporations

• Estate or trust income

 

The following types are considered earned or unearned depending on

whether the individual is actively engaged in earning the income and the self-employment tax forms filed.

• Farm rental income

• Other rental income

 

The earned income must be separated from the unearned income and will be when using the self-employment calculation worksheet.

 

Determining Self-Employment Income

  1. Capital or Ordinary Gains or Losses – A capital or ordinary gain or loss is the difference between the sale price and the cost basis. The cost basis may include improvements and sales expenses such as broker’s fees and commissions.

 

Capital or ordinary gains or losses are considered part of the EARNED income from self-employment. The gain or loss is calculated by deducting the cost basis from the gross sale price. The result is then added to or subtracted from the calculation of the self-employment income for the business the property was used in.

 

NOTE: Use only the income or loss from the sale of capital items that can be reasonably anticipated to recur during the current year.

 

This income is generally included on the Schedule D or Form 4797.

 

2. Farm Income – Income earned through the operation of a farm or ranch including farm rental income and CPR.

  1. Farm Rental Income – Income received by a landowner from the sale of crops or livestock produced by the tenant. This does not include cash rent of pasture or farmland.

 

  1. Conservation Reserve Program Payments (CRP) – Cost share and payment program under the USDA that encourages farmers to convert highly erodible crop land or other environmentally sensitive acreage to vegetative cover.

 

Farm income, including farm rental income and CRP:

 

The amount of cooperative distributions is deducted from farm income as it is considered unearned income. Depreciation is added back in as this is not an allowable expense.

 

This income is generally included on the Schedule F.

 

 

The amount of cooperative distributions is deducted from farm rental income as it is considered unearned income on a separate line in the calculation. Depreciation is added back in as this is not an allowable expense.

 

This income is generally included on the Form 4835.

 

3. Business Income – Income earned through the operation of a business other than farming or ranching.

 

Business income is considered EARNED self-employment income. Business income is determined by taking the net business income profit or loss and adding in the depletion or depreciation. Depreciation and depletion are added back in as they are not allowable expenses.

 

This income is generally included on the Schedule C.

 

  1. Partnerships – A partnership is a self-employment business set up as a partnership with two or more partners. A partner’s share of income, gain, loss, deductions or credits is determined by a partnership agreement.

 

 

  1. Other Rental Income – Income received from the cash rental of property.

 

Other rental income is considered UNEARNED income as a result of self-employment. Rental income is determined by taking the total net rental income from all rental properties and adding in the depreciation or depletion. Depreciation and depletion are added back in as these are not an allowable expense. This income is generally included on Schedule E.

 

  1. Royalty Income – a percentage of gross or net revenues derived from the use of an asset or a fixed price of a unit sold of an item.

 

Income individuals receive from royalties is considered UNEARNED income as a result of self-employment. Royalty income is generally included on Schedule E.

 

  1. Cooperative distributions (patronage dividends) - are paid by cooperatives in cash or shares of stock. These dividends are similar to rebates paid based on the amount of goods bought or services used for the self-employment enterprise.

 

Income individuals receive from cooperative distributions or patronage dividends is considered UNEARNED income as a result of self-employment. Cooperative distributions or patronage dividends are generally included on Schedule F and Form 4835.

 

  1. S –Corporation – a separate business entity with 1 to 100 shareholder(s) that passes through the net profit or loss to their shareholder(s). The business profits are taxed at individual tax rates on each individual shareholder’s income tax.

 

Income shareholders receive from a corporation is considered UNEARNED income as a result of self-employment. This income is generally included on the Schedule K-1 (1120S). The shareholder’s income is determined by adding the shareholder’s share of depreciation or depletion to their ordinary business income, net rental real estate income, interest income and dividend income. Depreciation and depletion are added back in as these are not an allowable expense. Depreciation and depletion are generally found on the Form 1120S.

 

NOTE: An owner or employee of a corporation is not a self-employed individual because the business income and liabilities belong to the corporation, not the individual. Wages that an owner or employee receive from a corporation are considered earned income.

 

  1. Estate or Trust Income – Income received from an estate or trust.

 

Income individuals receive from estate or trusts is considered UNEARNED income as a result of self-employment. Estate or trust income is generally included on Schedule E.

 

Other Types of Self-Employment Income

The following types of income may or may not be listed on self-employment tax forms. If the income is not listed on the self-employment tax forms, the income must be verified separately.

 

  1. Qualified Service Provider (QSP) – Qualified Service Providers (QSPs) are individuals who provide care for people who want to continue to live in their own homes and communities. QSPs do not need to have a special certificate or license, but they do need to prove they have the skills to provide care.

    • QSP income is considered EARNED self-employment income when the individual is not an employee of an agency.

       

    • QSP income is considered regular earned income when the individual is employed by an agency.

       

  2. Boarder - Individuals or groups of individuals residing with others and paying reasonable compensation for lodging and meals.

 

Income from boarders is considered EARNED self-employment income when the individual providing the board is actively engaged in providing the lodging and meals and the boarder is not included in the household based on program policy.

 

To calculate income from room and board, take the monthly gross receipts less $100 per boarder.

 

Wages Paid to Family Members

Wages paid to family members are an allowable business expense. However, the wages paid to family members must be counted as earned income separately from self-employment income unless the earned income is specifically excluded by program policy.

 

The income tax forms identify wages paid to family members as wages or labor hired but does not separate outside labor hired from wages paid to family members. The household will need to identify and verify the amount paid to family members (canceled checks, W-2 forms, bank books showing transfer of funds).

 

Allowable Expenses

The following expenses are allowable deductions from self-employment income. Because the EAP Self-Employment Worksheet uses net income any of these expenses claimed on the tax form are already deducted. The Anticipated Self-Employment Worksheet also accounts for these expenses.

 

If a household verifies any of the following expenses incurred as a result of self-employment income that were not included on the tax forms, the expense must be allowed by deducting it from the net income.

 

 

Non-Allowable Expenses

The worker must determine if an expense is non-allowable based on whether the expense is part of producing income. The following expenses are not allowable deductions from self-employment income:

All self-employment income must be verified and documented in the case file. Annual self-employment income must be averaged over the number of months the business was in operation, even if the income is received in fewer months. The income that results from this prorate applies to applicants and recipients, and is used to determine eligibility and the benefit amount.

 

The prorata method of determining monthly income may not be practical in the following circumstances:

No income from any other source may be used to offset a self-employment loss.

 

When determining income based on income tax forms attention should be paid to other sources of income listed on page one of Form 1040. Other types of income that may be reflected on page one of Form 1040 are interest income, dividend income, rental income, royalty income, etc. Interest, dividend, rental and royalty income are to be considered separately from the self-employment income.

 

To arrive at the most equitable method for determining the amount of a household's countable earned income from self-employment, it is necessary to consider the type of business activity, expense, and income. Based on this concept, one of the applicable calculations identified below shall be used.

  1. Self-employed individuals whose business does not require the purchase of goods for resale. An example of this type of business is a person who provides child care services in their own home, a Qualified Service Provider (QSP) who is not an employee of an agency, etc. Such income may be accounted for on a monthly basis, or the income tax return from the previous year may be used if it reflects a full year’s operation. When the tax return is used, 1/12th of the annual gross income is monthly earnings. Twenty-five (25%) percent of the gross monthly earnings shall be disregarded to offset the cost of producing the income and will cover such things as additional food, utilities, supplies, etc. The remaining 75% is the gross monthly earnings. The appropriate share percentage must be applied to the gross monthly income based on the number of individuals listed on the self-employment schedules. This is the figure to which the appropriate earned income disregards are applied to arrive at monthly net income.
  2. Self-employed individuals whose business requires the purchase of goods for resale. Examples of this type of business enterprise include Avon, Tupperware, Amway, Mary Kay Cosmetics, etc. Such income may be accounted for on a monthly basis, or the income tax return from the previous year may be used if it reflects a full year’s operation. In these instances, subtract the cost of the goods from the gross monthly or annual receipts to arrive at the adjusted gross income. If the cost of goods includes any labor or wage amounts, those amounts must be deducted from the cost of goods before subtracting the cost of goods sold from the gross monthly or annual receipts. When the tax return is used, 1/12th of the annual adjusted gross income is monthly earnings Twenty-five (25%) percent of the adjusted gross income shall be disregarded to offset the costs of producing the income and will cover such things as sample kits, demonstrations, supplies, etc. Seventy-five (75%) percent of the adjusted gross income will be the monthly income. The appropriate share percentage must be applied to the monthly adjusted gross income based on the number of individuals listed on the self-employment schedules. This is the figure to which the appropriate earned income disregards are applied to arrive at monthly net income.
  3. Self-employment income from a room-and-board arrangement. The first $100 per month received from each individual will be disregarded to defray the associated expenses. The remaining amount(s) will be the monthly income to which the appropriate earned income disregards are applied to arrive at the monthly net income.
  4. Self-employed individuals in a service business requiring purchase of goods or parts for repair or replacement. These include mechanics, TV repairmen, beauty salons, restaurants, etc. Such income may be accounted for on a monthly basis, or the income tax return from the previous year may be used if it reflects a full year’s operation. In this instance, subtract the cost of goods or parts from the gross monthly or annual receipts to arrive at the adjusted gross income. If the cost of goods or parts sold includes any labor or wage amounts, those amounts must be deducted from the cost of goods or parts before subtracting the cost of goods or parts from the gross monthly or annual receipts. When the tax return is used, 1/12th of the annual adjusted gross income is monthly earnings. Seventy-five (75%) percent of the adjusted gross monthly income shall be disregarded to offset the cost of expenses such as heat, lights, phone, rent, or building, etc. Twenty-five (25%) percent of the adjusted gross income will be the monthly income. The appropriate share percentage must be applied to the monthly adjusted gross income based on the number of individuals listed on the self-employment schedules. This is the figure to which the appropriate earned income disregards are applied to arrive at monthly net income.
  5. Income of self-employed individuals received other than monthly. In such cases, income must be established on the basis of the past year's total income to arrive at the amount of income to be anticipated for the current year and reduced to monthly increments. This is the preferred method of considering income arising from self-employment such as farming or other business enterprises. It is first necessary to establish the amount of total annual gross income. For purposes of CCAP, annual net income is normally defined as one-fourth of the annual gross income shown on Schedule F, Part I, of U.S. Form 1040, "Individual Income Tax Return," if the business is farming, or annual gross income shown on Schedule C, Part I, of Form 1040, if the business is other than farming.
  6. CRP payments and cooperative distributions, which are considered unearned income, should be deducted from the total income figure on Form 1040, Schedule F, and prorated over a 12-month period.

 

After the appropriate percentage disregard is applied to self-employment income, capital gains and losses are considered. Income resulting from the sale of capital items or ordinary gains may be offset by a loss from the sale of capital items. The net result (but not less than zero), must be added to the other annual net income to arrive at total net annual income.

Note: Capital gains and losses are always counted when considering actual income for a prior period. When using the prior income to estimate income for a prospective period, however, use capital gains and losses that are reasonably expected to occur in the prospective period.

Capital gains, short term and long term, and ordinary gains are found on the federal tax form as follows:

  1. Short term capital gains-Schedule D, Part I
  2. Long term capital gains-Schedule D, Part II
  3. Ordinary gains-Form 1040-Supplemental gains or losses

The following example demonstrates this process:

 

                 
            Gross annual income (from federal income tax return) $16,500.00  
            Net annual income (25% of $16,500) 4,125.00  
            Capital and other gains 1,200.00  
            Yearly income 5,325.00  
            Monthly income (yearly income divided by 12) 443.75  

 

The appropriate share percentage must be applied to the monthly adjusted gross income based on the number of individuals listed on the self-employment schedules.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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