3003-4      INCOME FROM SELF-EMPLOYMENT

Self-employment endeavors vary depending upon the nature of each self-employment enterprise. Exact instructions fitting every situation are impossible to provide. Therefore, caseworkers must use prudent person judgement in determining all factors related to budgeting self-employment income and must carefully and thoroughly document relevant information.

Relevant information includes the type of verification used to determine adjusted gross self-employment income and allowable costs of doing business (noting expenses which are not allowed), the budgeting method used, and for seasonal self-employment income, the period of self-employment.

3003-4 A.      DEFINITIONS RELATING TO SELF-EMPLOYMENT

1. Definition of Self-Employment

Self-employment is the process of actively earning income directly from one's own business, trade, or profession. Persons are considered self-employed if they:

• Are responsible for obtaining or providing a service or product;
• Earn income directly from their own business;
• Are not required to have federal income tax and FICA payments withheld from their earnings;
• Are not required to complete an IRSInternal Revenue Service W4 form for an employer; and,
• Are not covered by worker's compensation.Are

Self-employment may include income from a trade or business, hobby, commercial boarding house, rental property, or other income producing property. Examples of self-employed individuals include:

2. Self-Employed Fisherpersons

Owners of fishing boats and individuals holding fishing permits are considered self-employed fisherpersons if they are actively involved in the fishing operation.

Individuals who lease their boat or fishing permit and are not actively involved in the fishing operation are not considered self-employed fisherpersons. In these cases, the income obtained from the lease of the boat or permit is considered rental property income.

3. Rental Income

Rental income is treated as self-employment income when the owner of the property is actively engaged in the management of the property at least 20 hours per week. The adjusted gross income is considered earned income.

When the property owner is not actively engaged in the management of the property for at least 20 hours per week, costs of doing business are deducted from the rental income and the adjusted gross income is considered unearned income. See HAPHeating Assistance Program MSManual Section 3002-1, 3003-1B, and Addendum G.

Note:

Rental income received in a lump sum shall be averaged over the months intended.

Income received from the lease of a limited entry fishing permit is considered unearned rental income.

4. Monthly Self-Employment Income

Monthly self-employment income is self-employment income that is, or could be, earned on a monthly basis during any or all months throughout the year. Examples of individuals with monthly self-employment income include:

5. Seasonal Self-Employment Income

Seasonal self-employment income is self-employment income that is earned during a specified season or during part of a year. Examples of individuals with season self-employment income include:

6. Gross Self-Employment Income

Gross self-employment income means the total amount of money the trade or business produces. Gross self-employment income is computed by totaling the gross business receipts (income) for the business enterprise. Allowable costs of doing business are not deducted in determining gross self-employment income.

7. Adjusted Gross Self-Employment Income

Adjusted gross self-employment income means the gross self-employment earnings less allowable costs of doing business. Allowable costs of doing business can be determined by using the self-employment standard deduction or actual costs of doing business. To determine adjusted gross self-employment income, subtract the total amount of allowable costs of doing business from the gross self-employment earnings. The amount of self-employment earnings countable to a self-employed individual is the adjusted gross self-employment income.

8. Self-Employment Costs of Doing Business

Self-employment costs of doing business can be determined by allowing the self-employment standard deduction from gross income or actual expenses if the household believes their costs were more than 50% of their gross earnings. Self-employment costs of doing business are those declared non-personal expenses that are directly related to producing the self-employment income, and which are not specifically prohibited. If an expense is determined to be an allowable cost of doing business, the expense is deducted in computing adjusted gross income whether it is paid or not.

Refer to HAPHeating Assistance Program MSManual Section 3003-4B

9. Durable Goods

Durable goods are items of value purchased for use in the self-employment enterprise that are normally used for more than one year or season and can usually be sold once the self-employment business ends. Durable goods include items such as:

10. Period of Self-Employment

The period of self-employment is the number of months in which a seasonally self-employed individual is actively engaged in producing, or attempting to produce, self-employment income. The period of self-employment does not include months in which maintenance or preparation of tools or equipment is the only self-employment activity performed.

3003-4 B.      COSTS OF DOING BUSINESS

Allowable costs of doing business are determined using either the self-employment standard deduction or actual allowable expenses. The worker must give the household the choice of using actual expenses if they believe their expenses exceed the amount allowed using the standard deduction. If the household chooses to use actual expenses, they must provide verification of the expenses.

See Example 3 below for an explanation of when to use the standard deduction and when to use actuals.

1. Using the Self-Employment Standard Deduction as Cost of Doing Business

The self-employment standard deduction is 50% of the estimated gross self-employment income.

Example:

Joe is self-employed as a carpenter. His gross self-employment income is $2,000 per month. The allowable costs of doing business are $1,000 ($2,000 x 50%). Joe's adjusted gross self-employment income is $1,000.

2. Using Actuals as Cost of Doing Business

If the household believes their self-employment expenses are higher than 50% of their gross  self-employment income, they may claim actual expenses as their cost of doing business.

a. Expenses Allowed as Costs of Doing Business

Allowable costs of doing business, directly related to the business, include but are not limited to:

• Labor, including gross wages for an employee, employee life and health insurance premiums, and mandatory employer contributions to employee benefits plans such as Unemployment Insurance and Social Security.
• Payments made to a self-employed helper, such as costs for contracted work, shares paid to a self-employed crew member, etc.
• Stock and inventory, including the actual amount plus tax of a product purchase for resale.
• Raw materials.
• Purchase of durable goods.
• Interest and principal paid on loans to purchase durable goods.
• Insurance premiums, taxes, assessments, and utilities for income producing property.

If the household's home is used as the place of business, a percentage of the mortgage interest and principal, insurance, taxes, and utilities can be allowed as costs of doing business. To be allowed these costs, the self-employed individual must provide a description of the portion of the home used in the business, proof of the gross amount of the expenses, and a reasonable method for estimating the proportion of expenses attributed to the business (such as a percentage of use, amount claimed under IRSInternal Revenue Service rules, etc.)

The portion of the costs allowed as business expenses is not allowed as shelter costs in the heating assistance budget.

• Service, maintenance, and repair of business property and equipment.
• Rental of business property and equipment.
• Business supplies.
• Advertisement.
• Licenses and permit fees.
• Legal and professional fees, such as fees paid to lawyers and accountants.
• Business travel, including mileage and costs incurred by self-employed individuals to travel outside their community to work, sell goods or services, purchase business equipment, and seek repair of business equipment. Travel must be directly related to business. Transportation to and from work is not an allowable cost of doing business.
• Purchase of non-durable items.
• Vehicle expenses.

If a vehicle is used less than 50% of the time for self-employment reasons, allowable business-related expenses include gas, oil, registration and licensing fees, insurance, interest and principal payments on vehicle loans, necessary service and repairs, and replacement of worn items (such as tires.) Do not allow vehicle depreciation as a business expense.

If a vehicle is used less than 50% of the time for self-employment, allow the business mileage rate permitted by the Internal Revenue Service. Refer to http://www.irs.gov/taxpros/article/0,,id=156624,00.html for current standard mileage rates.

The IRS business mileage rate is the only deductible expense allowed for a vehicle used less than 50% of the time for self-employment. To received the mileage allowance, the self-employed individual must provide reasonable documentation of their business-related mileage.

• Year-round boat moorage
• Utility costs to maintain the boat year-round
• Crew meals and crew transportation, if paid by the self-employed individual

If the cost of meals for crewmembers is not identifiable, the allowable cost is determined by prorating the total cost of meals by the number of individuals on the boat. The result is the prorated cost for each individual. If food expense is deducted from the amount paid to a crewmember, the amount deducted is not allowed as a cost of doing business.

A meal deduction is not allowed for the self-employed individual or for any member of the HAPHeating Assistance Program household.

b. Expenses Not allowed as Costs of Doing Business

Expenses not allowed as costs of doing business are:

• Depreciation and amortization.
• Net losses from previous periods.
• Federal, state, and local income taxes.
• Monies set aside for retirement purposes except when paid for an employee who is not a member of the heating assistance household.
• Personal work-related expenses, such as transportation to and from work and child or dependent care.
• Normal living expenses for the self-employed individual and his or her family, such as shelter and food.
• Personal costs for the self-employed individual and his or her family, such as life and medical insurance and entertainment.

3. Examples Clarifying the Use of the Standard Expense Deduction

Below are examples of actions taken using the standard expense deduction.

Example #1: Actual Expenses Total Less than the Standard Deduction

Maria applies for assistance and states she wants to claim actual expenses because she believes they are greater than 50% of her gross income. After receiving verification of her expenses, the worker determines her actual expenses are less than the standard deduction. The standard 50% deduction is allowed because it results in a higher benefit to the household. A clear explanation of why the standard deduction was used must be included in the notice to the client and this action documented on the ECOSEnergy Community Online System notes screen.

Example #2: Requested Verification Not Provided

Brian submitted an application on October 2. He states he wants to claim actual expenses so the worker pends the application for verification of these expenses. Brian did not provide proof of his expenses by the requested date. Instead of denying the application, the worker works the case and allows the 50% standard deduction. The notice to Brian must explain that the 50% standard deduction was used because he did not provide proof of his expenses by the requested date.

Example #3: Lack of Business Expenses

Carolyn reports she is self-employed as a dog walker. She has no expenses for her business. Since she has no expenses, the self-employment standard deduction is not allowed.

3003-4 C.      VERIFICATION OF SELF-EMPLOYMENT INCOME AND EXPENSES

Written or verbal verification of self-employment income and expenses is required. Verification may include records showing the history of income and expenses, or documentation for what is expected to be received and spent in the future. Written verification is preferred and includes tax returns or business records. If written verification of self-employment income and expenses is not readily available, verbal verification is acceptable. Verbal verification can be received from collateral contacts or the self-employed individual. Verification of expenses, whether verbal or in writing, must contain enough information for the caseworker to determine allowable expenses. If an expense is not identifiable, the expense is not allowed as a cost of doing business. If the information received is questionable, additional clarification and verification must be sought. Administrative Procedures MS 105-1 C provides policy on when information is considered questionable.

1. Self-Employment Business Records

The self-employed person's written business records are the best and preferred method of verification. Self-employment has no employer verification. The self-employed person is the employer, and thus, business records maintained by the individual are acceptable verification.

The self-employed person has primary responsibility to tabulate the income and expense types and amounts in an organized manner. Acceptable business records range from informal personal records, such as a listing of receipts for business income and costs of doing business, to professionally prepared documents such as financial statements. If written business records are not maintained or readily available, such as during a telephone interview, the statement of the self-employed person or collateral contact may be used.

The verification used must include sufficient information to determine when income was received and costs incurred and if the costs are allowable. The caseworker should document the information including detail of the type of expense, the amount of the expense, and whether it is allowable. Individual receipts for income and costs may be requested if additional information is needed or any of the items listed are questionable.

2. Tax Forms

Income tax documents provide acceptable documentation of self-employment income and expenses. Such forms include: Form 1040 Individual Income Tax Return, Schedule C Profit or Loss from Business, Schedule E Supplemental Income and Loss, Schedule F Profit or Loss from Farming, Form 1065 Partnership Return of Income including Schedule K-1 Partner's Share of Income, and Form 1120-S, Income Tax Return for an S-Corporation including Schedule K-1 Shareholder's Share of Income.

Some costs of doing business allowed by the IRS, such as depreciation, are not allowable costs of doing business under public assistance program policy. When using tax forms as verification, review the claimed expenses, noting which are allowed under program rules.

3. Third Party Contacts

Written documentation from a third party verifying the self-employed person's income or expenses is acceptable. This may include verification from city or borough offices, taxicab stand owners, parent companies, fish processors/canneries, and the Department of Fish and Game.

3003-4 D.      UNIQUE SELF-EMPLOYMENT SITUATIONS

1. Household Members as Employees

For some households, the self-employment enterprises involves more than one member. In some of these cases, household members may be paid wages, contract payments, or crew shares of the catch proceeds from the enterprise. In these situation, the payments are treated as follows:

• When a dependent child in the household receives payment of wages, contract payments, or crew shares for work in the self-employment enterprise, the amount paid to the child is not an allowable cost of doing business and the wages/shares do not count as income to the child. The amount paid to the child is not deducted from the gross self-employment income for the enterprise.
• When another adult in the household receives payment of wages, contract payments, or crew shares for work in the self-employment enterprise, the amount paid to the adult is an allowable cost of doing business when allowing actual deductions and the wages/shares count as earned income to the adult receiving the payment. The amount paid to the adult is deducted from the gross self-employment income for the enterprise.

In other situations, the self-employment enterprise may be established as a partnership or S-corporation and more than one household member may share in the total business income. In these situations, the income received is counted as income as described in the following section.

2. Partnerships and Corporations

Most self-employment enterprises are owned and operated by a single individual and all of the business income belongs to that individual. These are known as sole proprietorships and the individual's countable income from these enterprises is determined by subtracting the total allowable costs of doing business from the total business receipts. Any salary or disbursement received by the individual from the business is not considered in the calculation of the gross self-employment income. These amounts are not allowable costs of doing business and are not deducted from the gross self-employment income for the enterprise.

Self-employment enterprises may also be formed as partnerships and corporations, which means that business income is shared.

Following are descriptions of these types of enterprises.

a. Partnerships

Some enterprises involve a partnership, which means two or more individuals have agreed to manage the business together and share the business income. A written agreement is not required for a partnership to exist, but there may be one. An individual's countable income from these enterprises is determined by subtracting the total allowable costs of doing business from the total business receipts, and dividing the amount by each partner's share. The share of income from a partnership is countable even if it is not distributed. Any salary or disbursements received by the individual from the business is not considered in the calculation of the gross self-employment income. These amounts are not allowable costs of doing business and are not deducted from the gross self-employment income for the enterprise.

A partnership is required to file an income tax Form 1065 Partnership Return of Income including Schedule K-1 Partner's Share of Income, which shows the income and expenses for the business. Unless the partnership is a new business, each partner should have a copy of these forms for reporting their share of the income.

Some partnerships involve a general partner, who is actively involved in operating the business, and a limited partner, who is an investor only, not an active participant. The general partner is considered self-employed and their portion of the income from the partnership counts as self-employment income. Any income received by the limited partner is treated as unearned income.

b. Corporations

A business may be a corporation, which is a distinct legal entity with legal status separate from the individuals who form it. One types of corporation, the S-corporation, is considered a self-employment enterprise. It confers a special tax status to shareholders and operates like a partnership. Income from an S-corporation is taxed at the individual level and is treated like self-employment income from a partnership. The income is passed through to the shareholders based on each shareholder's pro rata share.

The S-corporation must file a Form 1120-S, Income Tax Return for an S-Corporation including Schedule K-1 Shareholder's Share of Income. Unless the corporation is a new business, each shareholder should have a copy of these forms for reporting their share of the income.

Another type of corporation, the C-corporation, is not considered to be self-employment enterprise. In the C-corporation, taxes are paid on business income by the corporation and not by the stockholders. If profits are distributed to the stockholders as dividends, the dividend is treated as unearned income to the stockholder. An individual may receive a salary from a C-corporation. The salary is counted as wages, not self-employment income, even if the individual is the primary stockholder in the corporation. Such wages may include in-kind compensation resulting from the business paying for personal and household bills. Stocks that individuals own in these corporations are counted as resources, even if they are not publicly traded on the stock market.

3003-4 E.      SELF-EMPLOYMENT ANNUALIZATION STANDARD

Each season, HAPHeating Assistance Program establishes a self-employment annualization standard. The annualization standard is used to determine if a prior month figure can be used for very low-income households with self-employment income, rather than the 12-month computation. See MSManual Section 3000-2 Definitions "Gross Monthly Income."

To apply the annualization standard, the caseworker compares the gross amount of the self-employment ventures (after expenses) with the annualization standard. If the total annual adjusted gross self-employment income is equal or less than the annualization standard, the worker will compute the adjusted gross self-employment income of the calendar month prior to the month of application. If the total annual adjusted gross self-employment is more than the annualization standard, then the previous 12-month income average will be used to determine eligibility. 

Example 1:

Ralph applies for heating assistance for his household of 3, in November. He is a self-employed fisherman and earned $40,000 adjusted gross income in August.Ralph earns $0 in self-employment in October.

Since Ralph's adjusted gross self-employment income of $40,000 is less than the $46,000 annualization standard for a household of 3, we will count Ralph's self-employment of $0 for October.

Example 2:

Kelly applies for heating assistance for her household of 2, in January. Kelly's spouse is self-employed and earned $38,000 adjusted gross income for the last 12 months. Kelly's spouse was unable to work in December due to weather conditions and earned $0.

Since the spouse's adjusted gross self-employment income of $38,000 is more than the $36,000 annualization standard for a household of 2, the 12-month computation needs to be used. $38,000 / 12 months = $3,167 per month (rounded up to the nearest dollar per MSManual Section 3003-6.).