<p>I'm filling out FAFSA after finally getting my taxes back from my accountant yesterday. I realized I might have made a mistake last year, and want to be clear this year that I'm entering the tax correctly.</p>
<p>I have W-2 income and 1099 income. Line 55 on the 1040 is the total calculated tax "from work" while line 60 includes self-employment tax. FAFSA is asking for line 55. Why isn't it including the self-employment tax? For me this is an enormous additional tax. I realize that half of it is subtracted from income to compute AGI (Schedule SE, line 27 on the 1040) but line 60 is in fact the actual dollar amount that I pay in taxes. </p>
<p>Just trying to understand the rationale here.</p>
<p>Because the EFC formula is already calculating the employment taxes based on your income from work. That’s why FAFSA asks for each parent’s earnings in that way. In other words, the formula deducts the employee portion and you’re deducting the employer portion on line 27.</p>
<p>While FAFSA gives you credit for the full employee portion of FICA, line 27 only gives you an income deduction for 1/2 the employer portion (it is not a tax credit) - this lowers your EFC. And this deduction lowers your income tax, which raises your EFC. </p>
<p>Overall, for FAFSA purposes it’s equivalent to a deduction of about 36% of the employer portion (assuming a 28% incremental rate), rather than 100% like you get for the employee portion.</p>
<p>This could add $2000 or so to your EFC if you make $100K-ish, compared to what it would be if you got full credit for the full employer part. And unfortunately you’ve already spent that money on the tax, so you are screwed.</p>
<p>On the other hand, FAFSA doesn’t add back in a lot of work expenses (mileage, etc) that people who aren’t self-employed don’t get to take, so maybe it all evens out.</p>
<p>Yes, I get that not all income is the same, that “income from work” is W-2 income and subject to FICA and medicare withholding. And I get that FAFSA calculates an allowance for FICA based on W-2 income. But Federal income tax is Federal income tax. The EFC formula guide says “U.S. Income tax paid”. If I had only 1099 income, then line 55 would be zero and no taxes would be taken into account for FAFSA, even though I would be paying a substantial Federal income tax. </p>
<p>Two examples: </p>
<p>$100K in 1099 earnings, around $25K in self-employment taxes, none of which is reportable on FAFSA although AGI is reduced to $95K. EFC would be around $30K.</p>
<p>$100K in W-2 earnings, around $24K in reportable taxes/FICA on FAFSA, $100K AGI. EFC would be around $18K.</p>
<p>These aren’t real numbers, just made up ones but probably representative. Here’s a real number: my self-employed business deductions (mileage and tax prep) amounted to $1450 in 2010. </p>
<p>Just wondering why this makes sense from a big-picture perspective.</p>
<p>W2 income goes on line 7 of the 1040; self-employment income from 1099 falls through from schedule C to line 12 of the 1040. Both lead to federal tax on line 55.</p>
If you have 1099 income you pay both income tax <em>and</em> self-employment tax. You don’t only pay SE tax.</p>
<p>You get a deduction for 1/2 of the SE tax on line 27, but you don’t get a FASFA adjustment for paying the employer half, only the employee half.</p>
<p>Ok, self-employment tax is 15% of net profit, on top of the regular income tax. So self-employed pay more in taxes, for which there’s no corresponding allowance on FAFSA other than a reduction off the top of AGI. </p>
<p>But I think your calculation is incorrect above because the FAFSA formula doesn’t have any allowance for self-employed FICA (10K) or the other half of the SE taxes (assume 15K on line 56). If the 1099 employee has around the same individual taxes as the W-2 employee, that’s a total tax of $20K + $15K. So the 1099 employee calculation should be this (remove FICA, subtract half of SE tax from AGI):</p>
<p>FAFSA income = gross minus line 55 taxes plus business deductions (1.4k?) minus 1/2 SE tax
FAFSA income = 100K - 20K + 1.4K - 7.5K = 73.9K, EFC = 34.7K
amount available to pay EFC = 100K - 20K - 15K =65K
amount left = 65K - 34.7K = 30.2K</p>
<p>This is starting to be clearer :)</p>
<p>But is my $15K SE tax equivalent to your $10K FICA?</p>
<p>income: 100K
SE tax: 15K (7.5K employee, 7.5K employer)
FICA tax: 7.5K
income taxes: 20K
incremental tax rate: 28%
FAFSA “rate”: 47%</p>
<p>W2 employee:</p>
<p>FAFSA income = 100K - 20K - 7.5K = 72.5K
The 7.5K is the FAFSA FICA credit.
EFC = 72.5K * .47 = 34.1K</p>
<p>amount available to pay EFC = 72.5K
amount left: 72.5K - 34.1 = 38.4K</p>
<p>1099 employee:</p>
<p>FAFSA income = 100K - 7.5K - 20K + 2.1K - 7.5K = 67.1K
The first 7.5K is the deduction for 1/2 the SE tax on line 27, which lowers your income.
The 2.1K is added in because your income tax will be smaller due to the 1/2 SE deduction (7.5K * .28 incremental tax rate)
The second 7.5K is the calculated FAFSA credit for FICA.</p>
<p>EFC = 67.1K * .47 = 31.5K
amount available to pay EFC = 100K - 20K - 15K =65K
amount left = 65K - 31.5.6K = 33.5K</p>
<p>Business deductions factor in what falls to the 1040 from your schedule C. IOW, if you gross 100K and have no deductions, you put 100K on line 12 of the 1040. If you have $1500 in mileage, you would put 98.5K on line 12.</p>
<p>W2 employees don’t get to expense mileage, so this is a big advantage for the 1099 employee. Same with a home office expense, this deduction is generally not available to a W2 employee. So because of the deductions you can take as a self-employed person, this can totally counteract the “penalty” of not being able to subtract the other 1/2 SE tax from your FAFSA income.</p>
<p>Here’s a fun little self-employment twist . . . </p>
<p>Clergy, considered self employed. HOusing allowance not included on AGI, but listed as “unearned income”. One does get to pay self employment taxes on whole shebang, but as far as I can tell, since it’s unearned, there’s no FAFSA credit for half those SE taxes.</p>
<p>But that’s the thing, there is no calculated FAFSA credit for FICA if there’s no earned income. Earned (W2) income is zero, so the SSI allowance that FAFSA calculates is also zero. So that 2nd 7.5 K is not part of the allowances that FAFSA computes against AGI.</p>
<p>EFC = 74.6K * .47 = 35K
amount available to pay EFC = 100K - 20K - 15K =65K
amount left = 65K - 35K = 30K</p>
<p>I agree that 1099 employees who have legitimate deductible expenses can lower their net earnings accordingly. Unfortunately that’s not my situation, but on the other hand I don’t have much in the way of business expenses overall.</p>
<p>I am assuming that when the FAFSA asks for “Father’s/stepfather’s income earned
from work (FAFSA/SAR #87)” (line 2a) that this includes self-employment income as well, because self-employment income is still earned income. If it wasn’t, you wouldn’t have to pay SE tax on it.</p>
<p>But! Scrolling down a little farther in the FAFSA instructions, I come across this:</p>
<p>
</p>
<p>So I take it back, self-employed are not penalized by the disallowing of their FICA. In fact, they can report total W2 and 1099 income and the form will calculate FICA from all of it.</p>
<p>That was easy And it makes a huge difference in calculated EFC.</p>
<hr>
<p>But now another twist: I can’t find Box 14 [Code A] of IRS Schedule K-1 (Form 1065). I have a K-1 (form 1120S) and box 14 says “Foreign”. That can’t be right. Why can’t I just add line 17 from my 1040?</p>
Only the employee part. You are still penalized because you have to pay the employer portion as well, and you don’t get a full deduction for that.</p>
<p>Line 17 is rental/royalty income, this is unearned income so there is no FICA or SE tax on it. It will be included in your AGI on the FAFSA (line 1 I think) but not included in line 2, which is used only to calculate the FICA credit.</p>
<p>Box 14 on a K-1 form 1065 is “Self employment earnings”. I believe the K-1 form 1120S is for distributions from an S corporation, which is unearned income, therefore no FICA credit. Since you have a 1120S, there is nothing from that form that gets added to line 2 on the FAFSA.</p>
<p>Ok, I just realized the line numbers I am quoting are from the EFC Formula Guide, not the FAFSA. It looks like parents’ AGI is question 83, and father and mother’s earned income is questions 86 and 87.</p>
<p>No worries, I understood the AGI questions you were referring to.</p>
<p>I have an S-Corp which is why I have a K-1 (1120S), but the K-1/Form 1065 is a partnership form and so box 14 there is completely unrelated to the K-1/Form 1120S (could this be more confusing?).</p>
<p>Thanks for hanging in there with me - it saved me from making a big mistake in reporting earned income on FAFSA.</p>
<p>Make sure you don’t deviate from what is allowed (because the aid officer will adjust it if you do!). Using the Verification guide is a good idea … pull up the 10-11 FSA Handbook and find the Application and Verification Guide (yes, it’s last year’s but it explains things). Look for anything that addresses self employment income/taxes. I don’t have to deal with complicated self employment issues too often, but I do find that the guide is helpful when they come up. If the specific line/form/box/code is NOT listed, you don’t get to use it. </p>
<p>Probably not fair, probably doesn’t make sense. But that is the world of federal aid!</p>
<p>I realized that the “income from work” figure that I used last year was incorrect as I didn’t include my 1099 income. AGI was correct, but anything that used the income from work number as a basis (SS and state tax, I think) would be incorrect. Oh well, at least I caught it this year.</p>
<p>You don’t use the 1099 income for income from work unless it is listed on line 7. If it is included on Schedule C, it is part of Business Income/Loss (which is added to line 7 if positive or treated as 0 if negative).</p>
And it makes a huge difference in calculated EFC.</p>