Tax Q&A

Your Money

April 02, 2006

Baltimoresun.com's tax advice column features three experts from the Hunt Valley accounting firm SC&H Group answering questions about preparing your return. Here is an edited excerpt of this week's column:

In 2005, I had less income and more deductions than usual. The results were a bottom-line deficit, even after including my [self-employment] tax. The [self-employment] tax was $1,802. I am in my 70s and collect Social Security, even though I am still working full time. Nowhere does it say that I still need to pay the $1,802 [self-employment] tax, even though my bottom line is negative. I have called the IRS, and the person didn't know the answer.

- Jane, Sparks

The purpose of the self-employment tax is to pay the Social Security and Medicare portion that an employer and employee would normally pay if you worked for someone else.

Unfortunately, that is one of the drawbacks of working for yourself - you are responsible for both halves of the tax. The good news is that people that are self-employed are allowed to take half of it as a deduction.

However, regardless of your change in income and expenses, the tax is still required of all self-employed individuals.

Regarding your reduced income and increased expenses in 2005, as long as your net earnings from self-employment were more than $400, the tax is required.

Refer to Schedule SE and its instructions for more information. If you had a net loss from self-employment income, you should not owe any self-employment tax.

I am 74 years old, and my wife is 69. We are in good health. The question is: How much am I able to earn not counting my Social Security but on our interest income from bank accounts that consist of CDs and savings accounts? I receive a small pension from my company [from which] no taxes are taken out. The amount is $203 a month.

- Joe, Old Fort, N.C.

As you and your wife are above the full retirement age of 65, you are both entitled to receive full retirement benefits. However, there are limits to the amount of benefits. In 2005, the maximum monthly benefit was $1,939.

Also, if your income exceeds a specified base amount, then as much as 85 percent of your Social Security benefits will be taxed.

Assuming you file a joint tax return, if your income (including nontaxable interest income and one-half of your Social Security benefits) is less than $32,000, then none of your benefits is taxable.

If your income is between $32,000 and $44,000, then 50 percent of your Social Security benefits will be taxable.

Finally, if your income is greater than $44,000, then 85 percent of Social Security benefits will be taxed. The instructions to Form 1040 contain a worksheet to compute the taxable amount.

As an aside, don't forget to claim any Medicare Part B premiums you paid in 2005 as medical expenses on Schedule A. Those premiums should be noted on your SSA-1099.

My father receives a disability pension from Bethlehem Steel instead of the workers' compensation payments he previously received. He is 57 years old and receives Social Security disability payments. Is the pension taxable? And if so, can the amount of the pension be applied to the limit someone is allowed to make before Social Security becomes taxable?

- Sharon, Hanover

Amounts received by an employee from accident or health insurance because of injuries or sickness are taxable to the extent that such amounts are related to contributions by the employer that were not included in the employee's taxable income, or are paid directly by the employer.

You can generally exclude amounts that your father contributed to the insurance plan himself or employer contributions that the employer reported as taxable wages for your father.

After determining the amount of the disability pension that is subject to tax, this amount will be included in the calculation to determine the amount of the Social Security payment that is taxable.

Social Security disability payments are taxed in the same manner as other Social Security payments - there is no distinction between these payments for federal and Maryland income tax purposes.

To submit a question or read the columns online, go to www.baltimoresun.com/taxtalk.

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