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COLAs alter optional methods for determining self-employment earnings for 2014

October 31, 2013

The Social Security Administration has released various cost-of-living adjustments (COLAs) for 2014 including the quarter of coverage figure, which rises from $1,160 for 2013 to $1,200 for 2014. The increase in the quarter of coverage figure serves to increase the lower and upper limits under optional methods for computing self-employment tax, as explained below.

RIA observation: The optional methods may give an individual credit toward social security coverage even though he has a loss or a small amount of income from self-employment. They also may enable an individual to qualify for an earned income credit, additional child credit, and/or dependent credit or, in any such case, a higher credit.

Lower and upper limits under optional methods. Optional methods of computing self-employment earnings refer to the “lower limit” or “upper limit.” The “lower limit” for any tax year is the sum of the amounts required under Sec. 213(d) of the Social Security Act for a quarter of coverage in effect with respect to each calendar quarter ending with or within that tax year. (Code Sec. 1402(l)(1)) Thus, for 2014, it is $4,800 ($1,200 × 4). The “upper limit” is 150% of the lower limit. (Code Sec. 1402(l)(2))

Optional determination of nonfarm self-employment earnings. For 2014, an individual may use the nonfarm optional method only if (a) his net nonfarm profits were less than $5,198 and also less than 72.189% of his gross nonfarm income, and (b) he had net earnings from self-employment of at least $400 in two of the prior three years. This optional method permits individuals to compute their self-employment earnings as the smaller of two-thirds of gross nonfarm income or $4,800 for 2014. (Code Sec. 1402(a))

Farmer’s optional computation method. For 2014, an individual may use the farm optional method to compute his net self-employment earnings only if (a) his gross farm income was not more than $7,200 or (b) his net farm profits were less than $5,198. This method permits individuals to compute their farm self-employment earnings as the smaller of (1) 66—% of gross farm income, or (2) $4,800 for 2014. (Code Sec. 1402(a), Code Sec. 1402(l))

Using both optional farm method and optional nonfarm method. A self-employed individual with both farm and nonfarm incomes is allowed to use both optional computation methods if the farm income qualifies for the farm optional method and the nonfarm income qualifies for the nonfarm optional method. If both the nonfarm optional method and the farm optional method are used to compute net earnings from self-employment, the maximum combined total net earnings from self-employment for any tax year can’t be more than the lower limit amount ($4,800 for 2014). (Code Sec. 1402(a))