On the Iowa 1040, taxpayers are required to add federal self-employment tax for the current year into income for Iowa purposes. Why does Iowa require this?
Example
Joe the Window Washer is self-employed. In 2015, he received a federal tax refund of $1,000. In 2016, he owed federal self-employment tax of $5,000.
On his 2016 Iowa tax return, Joe will have to claim the $1,000 refund as income (remember, Iowa taxes federal tax refund) AND he’ll have to claim the $5,000 of self-employment tax as income as well.
Why???
Iowa makes taxpayers claim federal tax refunds as income because Iowa allows a deduction in full for federal income taxes paid.
The word “income” is put in bold letters for a reason.
Self-employment tax is NOT an income tax, it’s a FICA tax. Iowa doesn’t allow a deduction for FICA taxes paid.
So, Iowa makes you add self-employment tax to income, to ensure that any federal tax payments you’re deducting “net out” to the amount of income tax liability you had.
Example
Joe the WIndow Washer is self-employed. His 2016 self-employment tax comes to $5,000, his income tax liability comes to $4,000, and he made $10,000 of federal estimated tax payments.
On his Iowa tax return, Joe will claim a deduction for the entire $10,000 of estimated tax payments, even though $5,000 of that payment ended up being applied to self-employment tax.
Joe can deduct the entire $10,000, but has to claim the $5,000 of self-employment tax as income, so that the net result is no deduction for the SE/FICA portion of his tax liability.