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My wife has performed a few jobs as a dog walker/pet sitter through the Rover website. Her total for 2016 was $1,139.00 - $793.90 were transferred via PayPal and $345.10 were transferred via check.

She didn't receive any 1099 forms (either MISC, K, etc.) from either Rover or PayPal. I contacted Rover and they said that they only issue 1099 forms if more than $600 have been redeemed via check, and that PayPal only issues 1099 forms if more than $20,000 have been transferred out of your PayPal account (neither of them happened).

With that in mind, I manually added the values in TurboTax in the "Additional income" section. Our expected refund went from $3,121 (we are still waiting for some W2s) to $2,696. That's a total tax amount of $425 - more than 37% of the amount received!

Does anyone know an explanation for that?

(ps.: neither of us are permanent residents in the US)

  • 1
    Which tax bracket are you in? – Ben Miller Jan 20 '17 at 20:23
  • The 25% bracket. – Hill Jan 20 '17 at 20:24
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    yeah, you add the self employment taxes on top of the income taxes. case closed. (but now that you unlocked self employment tax deductions, you find all expenses related to the dog walking and deduct those too. subscriptions, networking, advertising etc.) – CQM Jan 21 '17 at 0:39
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    You'll need to file Form 1040SSE for the Social Security tax. 12% on top of your 25% bracket seems about right. However, you should also look at filing Schedule C, which lets you deduct any expenses incurred in the business. For instance, if your wife drove to people's houses to walk their dogs, she probably can deduct mileage driven - and at a standard rate that's quite advantageous if she has a fuel-efficient vehicle. – jamesqf Jan 21 '17 at 4:29
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That's a total tax amount of $425 - more than 37% of the amount received!

Taxes on self-employment income is usually pretty high since you are responsible to pay both the employer taxes and employee taxes. This essentially doubles the amount of medicare and social security taxes that you would usually pay as an employee. There are additional smaller taxes as well, partially depending on what state you live in.

  • That makes sense. I saw lower rates when I searched online, but I suppose the numbers I saw were related only to the employee side. – Hill Jan 20 '17 at 20:24
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    @Phil, It's definitely a pain to see a big chunk of your self-employment income disappear! Hopefully you can bring that down some by writing off your wife's pet-sitter expenses though – Nosrac Jan 20 '17 at 20:29
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    There are probably legitimate expenses due to running this business. For example if she drove to pet sit somewhere, you will probably be able to deduct mileage to and from the location. If she printed flyers to promote her business those might be deductible. Etc.. – Pete B. Jan 20 '17 at 21:07
  • @Phil Don't forget you can deduct half of the taxes for fica/medicare (around 7.7%) - the employer-side ones. – Joe Jan 20 '17 at 22:46
  • @Joe shouldn't TurboTax have done that automatically? – Mark Ransom Jan 20 '17 at 23:22
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You pay 15.3% for your payroll taxes. 6.2 for FICA, 1.45 for Medicare -- multiplied by two because self-employed individuals are paying both employee and employer portions.

5

Your specific case

$1,139.00 / 1.0765 = $1058.06

That's your taxable basis. There's also a way to do it with multiplication that is actually better due to rounding, etc. But this is the basic idea and is still an allowable way to do the calculation. This deducts out the employer share of Social Security and Medicare taxes, since the tax rate is charged minus those to match regular employment.

Your tax rate is 25% for income, 12.4% for Social Security, 2.9% Medicare. Note that Social Security and Medicare are both twice as large because you are paying the employer and employee shares.

$1058.06 * (.25 + .124 + .029) = $1058.06 * .403 = $426.40

So let's look at your refund again. It was actually reduced only $425 but should have been reduced $426.40. I'm not going to go through the actual forms to duplicate this, but it looks like rounding was your friend. You saved $1.40 in the real calculation.

The general case

It's easy to neglect the employer halves of Social Security and Medicare taxes, because if not self-employed, someone else (the employer) pays them. But they are hefty taxes and significantly increase the marginal tax rate if self-employed. Actual marginal rates:

  • 10% pays 23.5%
  • 15% pays 28.15%

You can calculate this by e.g.

(.25 + .153) / 1.0765 = .37436...

Somewhere along there, the tax rate changes. Social Security has a maximum cap, and Medicare has a surcharge. So the higher tax brackets will start using different formulas, adding 2.9% or 3.8% instead of 15.3%. And dividing by 1.0145 instead of 1.0765. This would be complicated to calculate because the Social Security cap would be based on your wife's income--you have a separate cap on your income. So you could hit the cap and she could still be below it. It's not pooled like income taxes.

  • 25% pays 37.44% or 27.5%
  • 28% pays 40.22% or 30.46%
  • 33% pays 44.87% or 45.70% or 35.39% or 36.27%
  • 35% pays 47.56% or 38.25%
  • 39.6% pays 51.83% or 42.78%

In a situation similar to yours where one spouse makes only a small amount of income, the marginal rate could be as high as

(.396 + .153 + .009) / 1.0765 = .51834...

That's 51.83% in the 39.6% tax bracket. Such a spouse would be under the individual Social Security cap but above the family Medicare surcharge point. That's an extreme case though.

  • Thank you so much for the explanation! Do you know if TurboTax takes all that information into account when I input the income? – Hill Jan 28 '17 at 20:30
  • @Phil I do not know of my own knowledge. I would assume that they do though, that is of course the actual service that they're selling: to handle the complexity so that you don't have to do so. Most of this isn't so much difficult as persnickety. After you finish, you should be able to go through the forms in the PDF and see what they did. – Brythan Jan 28 '17 at 21:40
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Let's work it out.

First, there's your 15.3% self-employment tax (including the tax paid by the employer, but you are the employer). This tax is applied to the amount you would have made had you not been self-employed, which is 92.35% of the amount you made when you're self-employed. 15.3% of 92.35% of $1139 is $161.

Then there's income tax. You get a deduction of half your self-employment tax (because employees don't pay income tax on the employer's part). So that's 25% of $1139 minus 25% of half of $161. That's $265.

You add $161 and $265 and you get $426.

  • Remember that self-employment tax is applied to 92.35% of net income, so the taxable basis is $1052 instead of $1139. The self-employment tax works out to $161 instead of $174. The rest of the math works out to $425. – Robert Jan 22 '17 at 3:38

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