45.5 Optional Method If 2012 Was a Low-Income or Loss Year

The law provides a small increased tax base for Social Security coverage if you have a low net profit or loss. The increased tax base is called the optional method and is figured in Part II of Section B of Schedule SE. One optional method is for nonfarm self-employment and another for farm income. You may not use the optional method to report an amount less than your actual net earnings from nonfarm self-employment.

Nonfarm method.

You may use the nonfarm optional method for 2012 if you meet all the following tests:

Test 1. Your net earnings (profit) from nonfarm self-employment on Line 31 of Schedule C, Line 3 of Schedule C-EZ, or Box 14 (Code A) of Schedule K-1 (Form 1065) are less than $4,894.
Test 2. Your net nonfarm profits are less than 72.189% of your gross nonfarm income.
Test 3. You had net earnings from self-employment of $400 or more in at least two of the following years: 2009, 2010, and 2011.
Test 4. You have not previously used this method for more than four years. There is a five-year lifetime limit for use of the nonfarm optional base. The years do not have to be consecutive.
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Optional Method
Electing the optional method to increase the base for Social Security coverage may also increase earned income for dependent care and earned income credit purposes.
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If your net profit from all nonfarm trades or businesses is less than $4,894 and also less than 72.189% of gross nonfarm income, you may report two-thirds of the gross income from your nonfarm business as net earnings from self-employment for 2012.

EXAMPLES
1. Brown had net earnings from self-employment of $800 in 2010 and $900 in 2011 and so meets Test 3 above. In 2012, she has gross nonfarm self-employment income of $6,200 and net nonfarm self-employment earnings of $4,000. Net earnings from self-employment of $4,000 are less than $4,894 (Test 1 above) and also less than $4,476 (72.189% ×$6,200) (Test 2). Brown may figure self-employment tax on $4,133 (2/3 of $6,200).
2. Same facts as in Example 1, but Brown has a net self-employment loss of $700. She may elect to report $4,133 (2/3 of $6,200) as net earnings under the optional method.
3. Smith had gross nonfarm income of $1,000 and net nonfarm self-employment earnings of $800. He may not use the optional method because net earnings of $800 are not less than 72.189% of $1,000 gross income, or $722.
4. Jones has gross nonfarm income of $525 and net nonfarm self-employment earnings of $175. Jones may not use the optional method because two-thirds of his gross income, or $350, is less than the minimum income of $400 required to be subject to the self-employment tax.

Optional farm method.

If you have farming income (other than as a limited partner) you may use the farm optional method to figure your net earnings from farm self-employment.

You can use the nonfarm optional method for 2012 only if your gross farm income was not more than $6,780 or your net farm profits were less than $4,894.

You may report the smaller of two-thirds of your gross income or $4,520 as your net earnings from farm self-employment.

Farm income includes income from cultivating the soil or harvesting any agricultural commodities. It also includes income from the operation of a livestock, dairy, poultry, bee, fish, fruit, or truck farm, or plantation, ranch, nursery, range, orchard, or oyster bed, as well as income in the form of crop shares if you materially participate in production or management of production.

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