We are well into tax season. But if you’re a busy self-employed sole proprietor, partner, or LLC member, you might not have gotten around to filing your 2020 Form 1040. If so, you are forgiven. The good news: if you’ve stayed on the sidelines so far, it could actually turn out in your favor — because there are some new tax breaks that you may be blissfully unaware of. Here’s the story on two important ones. Take advantage if you can.
Defer some self-employment tax
If you’re self-employed, you know that the self-employment (SE) tax can take a big bite out of your wallet every year. Ouch. Thankfully, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) allows you to defer half of your 2020 liability for the 12.4% Social Security tax component of the SE tax for the deferral period. The deferral period began on 3/27/20 and ended on 12/31/20. You must then pay the deferred SE tax amount in two installments:
- Half by 12/31/21
- The remaining half by 12/31/22
If you’re cash-strapped, this can be a very helpful deal, and you should take full advantage.
If you owe the maximum $17,075 for the 2020 Social Security tax portion of the SE tax, it works out that you can potentially defer up to half of that amount, or $8,537. You would then pay in $4,268.50 by 12/31/21 and the remaining $4,268.50 by 12/31/22.
Tax-saving tip: Fill out Part III of Schedule SE to calculate the exact amount that you can defer. Then carry the deferred amount to Schedule 3 of Form 1040 where it’s treated as a credit that reduces your 2020 federal income tax liability on page 2 of your return. Done.
Claim tax credits for COVID-19-related sick leave and family leave taken last year
The Families First Coronavirus Response Act (FFCRA) granted two separate 2020 federal tax credits to small employers to cover: (1) mandatory payments to employees who took time off between 4/1/20 and 12/31/20 under the FFCRA’s COVID-19-related emergency sick leave provisions and (2) mandatory payments to employees who took time off between those dates under the FFCRA’s emergency family leave provisions.
Somewhat surprisingly, equivalent tax credits are available to you as a self-employed individual if you took days of qualified sick leave or qualified family leave between 4/1/20 and 12/31/20. In effect, you can claim credits for amounts that you paid to yourself for: (1) qualified sick leave days and (2) qualified family leave days. Nice. Here’s what you need to know to cash in.
Sick leave credit details
The sick leave credit is allowed for sick leave days that you took between 4/1/20 and 12/31/20. The daily sick leave credit equals: (1) 100% of the daily sick-leave equivalent amount plus (2) 67% of the daily sick-leave equivalent amount if you took leave to care for a sick person or to care for an under-age-18 son or daughter following the closing of the child’s school or place of care or because the childcare provider for the child was unavailable due to COVID-19 precautions.
The daily sick-leave equivalent amount equals the lesser of: (1) your average daily self-employment income or (2) $511 per day for up to 10 sick days (up to $5,110 in total) to care for yourself or $200 per day for up to 10 days (up to $2,000 in total) to care for another sick person or to care for an under-age-18 son or daughter for any of the aforementioned reasons.
Average daily self-employment income means your net self-employment earnings for 2020 divided by 260.
Family leave credit details
The separate family leave credit is allowed for family leave days that you took to care for an under-age-18 son or daughter between 4/1/20 and 12/31/20 following the closing of the child’s school or place of care or because the childcare provider for the child was unavailable due to COVID-19 precautions.
You can claim the family leave credit for a maximum of 50 days. The allowable credit equals the number of qualified family leave days multiplied by the lesser of (1) $200 or (2) your average daily self-employment income.
The maximum total family leave credit is $10,000 (50 days × $200 per day).
Once again, average daily self-employment income means your net self-employment earnings for 2020 divided by 260.
You should maintain documentation to establish your eligibility for these credits. According to the IRS website:
- If you took sick leave days for yourself based on a quarantine order or advice to self-quarantine, document the name of the governmental entity ordering quarantine or the name of the health care professional who advised self-quarantine. If you took sick leave days to care for another person who was subject to quarantine or advised to self-quarantine, document the other person’s name and relationship to you.
- If you took family leave days to care for an under-age-18 son or daughter due to a school closing or child care facility closing or child care provider unavailability, document the name and age of the child; the name of the school, summer camp, summer enrichment program, or other summer program that was closed; or the child care facility that was closed; or the child care provider who was unavailable. Be prepared to state that no other person cared for the child during the days you took family leave.
Tax-saving tip: These two credits are so-called refundable credits. That means you can collect them even if you don’t have any federal income tax liability for 2020. But you must file your 2020 Form 1040 to cash in. First, calculate the credits on new IRS Form 7202 (Credits for Sick Leave and Family Leave for Certain Self-Employed Individuals). Then carry the credits to Schedule 3 of Form 1040 where they are treated as refundable credits on page 2 of your Form 1040.
Another tax-saving tip: You can elect to use your 2019 net self-employment earnings to calculate your average daily self-employment income for purposes of calculating these credits. Do that if it would result in bigger credits. To make the election, simply enter the larger 2019 amount of net earnings from self-employment on Form 7202.
The bottom line
The COVID-19 pandemic, its economic fallout, and available federal income tax relief can make your 2020 Form 1040 a whole new ballgame. This column addresses two important considerations for self-employed individuals, but there are more. Your tax professional can work with them to optimize your tax-saving results for a year we would all like to forget.