Self-Employment Tax Penalty

Paying for College
1

<p>My dad, the sole wage-earner for my family, is a contractor and so functions as self-employed and files the forms and pays the taxes accordingly. Anyone who is self-employed and has filled out the FAFSA knows that the AGI they take does NOT include the "1/2 SE tax" credit given.</p>

<p>My father made just over $100,000, and his AGI ended up being around $95,000. The taxes that the FAFSA asks for say he paid only $13,000, but in reality he paid closer to $30,000, and the majority of it we were lucky enough to be able to pay in cash because we'd saved specifically in order to be able to pay the tax off.</p>

<p>Of course, this does mean that we have an effective spending salary in the neighborhood of $70k, not close to or over $100k. The main problem is twofold: the job my dad had last year was a contract which his no longer has this year, therefore he is not going to make anywhere near that amount in the year they expect us to pay from, and the prior years' financial history means we have a lot of debts we're recovering from (we went from full Pell Grant eligibility in my first year of college with an income <$50k for a family of 4 (typical of the previous 20 years' salary) to nothing but loans here for my last year).</p>

<p>I am more curious about the SE tax penalty. The nature of my dad's business does not allow for a whole lot of deductions as seems to be the point in penalizing the SE individual on tax and FAFSA forms. We obviously have 0 savings and assets. I know I am going to make an attempt at an appeal, but I am uncertain at what angle to pursue this; similar attempts last year proved fairly futile, despite a much lower salary (~$70k on the FAFSA, effectively ~$60k after SE taxes), and the basic consensus is that they assume SE people will deduct away most of the SE tax in the course of business.</p>

<p>HELP! I know there are other parents who have gone through things like this, and I really don't want to ask my parents to take out a $17,000 PLUS loan (in addition to my student loans and work) so I can finish college.</p>

2

<p>You are mistaken -- I am self employed, and there is no self-employment tax "penalty". One-half of self-employment tax is deducted from income to determine the AGI, and the other half is equivalent to FICA and already accounted for in the FAFSA formula when considering earned income. (That's why the FAFSA formula asks for entry of "earned income" in addition to to AGI -- in many cases, the "earned income" amount can be higher than AGI, but that figure is used to calculate FICA.)</p>

<p>So -- leaving off other possible income, credits or deductions, if your dad's net income from the schedule C was $100K, then self employment tax would be about $14,400 (since only the first $94K is subject to SE tax) -- his AGI would be $92,800 -- the other $7200 of SE tax would be accounted for within the formula, the same way that FICA would be, and of course the actual amount paid in income taxes would be deducted. Your dad is in essentially the same position as a $92,800 wage earner, with a very slight difference because the FICA for that earner is about $120 less -- but I think that works in your father's favor, as the formula would calculate his FICA against the total amount of earned income. </p>

<p>I agree with you that that you are in an unfortunate position because of the increase in income, but it is not the self-employment status that is creating the problem, it is the income fluctuations in your family. The bigger problem that self-employed people face is that financial aid offices often go over their schedule C's and add back in certain disfavored deductions, such as car expenses or depreciation -- but since you said that your dad's business does not allow for a lot of deductions, it probably is not an issue for you. (It can be a terrible problem for those in high-overhead, service-oriented professions). </p>

<p>The best thing for you to do is to present the actual facts as a hardship case and ask for an adjustment in EFC based on "professional judgment", giving the colleges as much real information as possible about family expenses. If any of the past debts are due to medical expenses, it might help to document that -- that sort of debt is likely to be viewed more favorably than consumer debt. </p>

<p>I am wondering whether you or your dad filled out the FAFSA incorrectly, since you seem confused about the AGI -- but in most cases the college would correct such mistakes once they had the tax returns to look at, so I doubt that is a major factor for your EFC. I think you may be confusing schedule C deductions with the SE credit on the 1040. Also, do you have health insurance? SE individuals can also get 100% credit on money paid for health insurance, which reduces AGI further, and I don't think employed individuals get a similar break for their share of insurance premiums on employer-subsidized policies.</p>