Are Unemployment Benefits Subject to Self-Employment Tax?

I’ve been asked this question a lot, from both tax pros and random people contacting me with this question: if I am self-employed and receive unemployment benefits under the CARES Act (or the latest stimulus bill), do I need to include those benefits as income on my Schedule C?

I don’t see this particular issue addressed with a specific yes or no answer anywhere, but it seems the answer is probably no, it is NOT income on your Schedule C, which is good because that means you’re not paying self-employment tax on it.

Let’s back up and start at the start. (Two tired cliches in one sentence, right there.)

Schedule C and Self-Employment Tax

Schedule C is the form self-employed people fill out to report their business income and expenses. It is part of their personal tax return.

If the Schedule C results in net income (i.e. the business turned a profit) the taxpayer will owe self-employment tax on the net income.* Self-employment tax is the self-employed person’s version of FICA taxes that are withheld from an employee’s paycheck. 

A self-employed person thus owes regular income tax on their net income, plus  they owe self-employment tax on their net income. Self-employment tax is 15.3% of net income** so the determination of whether or not unemployment benefits are put on the Schedule C is a big deal.

*-Did you know, if your net income is less than $434 you actually don’t owe self-employment tax at all?

**-The 15.3% is calculated on your net income times 92.35%; if the result of this multiplication is $434 or less you don’t owe self-employment tax

Unemployment Benefits

Generally a self-employed person is not able to claim unemployment benefits. The CARES Act changed that, and the recent stimulus bill (signed into law December 27th) extended the benefits. 

Because a self-employed person usually can’t claim unemployment, the issue of whether or not their unemployment benefits are self-employment income has not been addressed, that I can see. But we can say with some degree of confidence that the answer is: it probably is not self-employment income, based on how these benefits are treated for people who are not self-employed.

For regular old workers (not self-employed) who get laid off and draw unemployment, the benefits are subject to income tax but not FICA taxes. The word “benefit” is the key word. Unemployment “benefits” are just that: a benefit payment from the government, not payment for services. “Remuneration for services” is what the tax code says regarding “wages” subject to FICA taxes. An unemployment benefit is not payment for services.

So it would seem that unemployment benefits received by a self-employed person would not be Schedule C income and would not be subject to self-employment tax, because the self-employed person is not being paid for services rendered. Section 1402 of the Tax Code defines self-employment income as:  “the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed by this subtitle which are attributable to such trade or business…”

Caveat

There are usually caveats and things that make me say “wait a minute,” and so here’s the “wait a minute” moment on this subject.

In 2018 there was a District Court case in Wisconsin involving a dairy farmer who had sued a utility company after an issue with “stray voltage” caused damages on his farm. 

The farmer was awarded damages plus interest. The taxpayer did not include the interest portion of the settlement on his Schedule F (the farmer’s version of Schedule C).

The IRS contended that the interest payment on the lawsuit was self-employment income, and the court sided with the IRS on the grounds that the interest income, quote: “is “derived” from a trade or business and therefore subject to the self-employment tax when there is a nexus between the income received and the taxpayer’s trade or business.”

Could the IRS contend that unemployment benefits have a “nexus” with the taxpayer’s Schedule C? I think the answer would be no, on the grounds that unemployment benefits are “benefits” not directly related to services rendered. The lawsuit (Allen vs. U.S.) involved a case directly tied to the taxpayer’s dairy farm, where the damages were for actual economic losses (plus interest). 

On the other hand, one could say that the unemployment benefits are for economic losses (a replacement of self-employment income) of the proprietor and thus fall under the same treatment as the damages from this court case.

Conclusion

This is yet another opportunity for me to say: be kind to your accountant. 

Do you see the world we live in? I prepare 230 tax returns. Every single one of them has an oddity on it. The oddities are all different, but they’re similar to the topic discussed here: you can research something and come up with two different possible answers, as I did here. Someone else could research this same topic and find different answers. 

The scary thing is: we might both be right. 

Or we might both be wrong….