From the left column of page 5 of Publication 560 (for 2014):

“For SIMPLE plans, net earnings from self-employment is the amount on line 4 of Short Schedule SE or Long Schedule SE (Form 1040) Self-Employment Tax, before subtracting any contributions made to the SIMPLE plan for yourself.”

For most small businesses, the amounts in lines 1a and 1b of the Short Schedule SE are both 0 and the amount in line 3 is simply the net profit from business entered in line 2 of Short Schedule SE from Schedule C or C-EZ. The amount in line 4 is the net profit from line 3 multiplied by .9235.

Suppose that Joe, age 40 has a sideline business and that his income from this business, after expenses, but before subtracting half of the self-employment tax, is $30,000. His “net earnings from self-employment,” for a SIMPLE IRA is equal to .9235 × $30,000 = $27,705. His employer contribution is .03 × $27,705 = $831.15. The multiplier is .03, not 3/103, because of the above instruction in quotation marks from Publication 560. His maximum employee deferral is $12,500, so his total SIMPLE IRA maximum deduction is $13,331.15.

Publication 560 (for 2014) has an example on pp. 24 and 25 of a sole proprietorship with no employees other than the owner-employee, with income after business expenses, but before subtracting half of the self-employment tax or the employer contribution to the plan, of $200,000. The calculation of the maximum contribution uses a contribution rate of r/(1+r) because the above instruction in quotation marks from Publication 560 applies only to SIMPLE plans. Publication 560 does not specify what kind of plan is illustrated on pp. 24 and 25, but the contribution rate of 8.5% suggests that it is either a SEP IRA or a Keogh money purchase pension plan.

In addition to the use of a contribution rate of r/(1+r), rather than r, for the SEP IRA or Keogh plan, the deduction of half of the self-employment tax is calculated differently for the SIMPLE IRA and the SEP IRA or Keogh plan. For a SIMPLE plan this amount is “simply” the Schedule C or C-EZ bottom line multiplied by .0765, (1 – .9235) because the amount in line 4, which is specified in the instruction on page 5, as net earnings from self-employment, is the Schedule C or C-EZ bottom line multiplied by .9235. This instruction skips lines 5 and 6 of Schedule SE.

The deduction for half the self-employment tax, with self-employment income of $30,000 is $30,000 × .0765 = $2,295.00, in accordance with the page 5 instruction. The deduction for half the self-employment tax, with self-employment income of $30,000 is $30,000 × .9235 × .153 × .5 = $2,119.43, in accordance with Schedule SE.

Questions:

Should a deduction for half the self-employment tax of $2,295.00 be used if the business has a SIMPLE IRA?

Should a deduction for half the self-employment tax of $2,119.43 be used if the business has a SEP IRA?

Publication 560 suggests that the answers are YES and YES.

Should a deduction for half the self-employment tax of $2,119.43 be used regardless of whether the business has a SEP IRA, a SIMPLE IRA, a Keogh plan or no tax-qualified retirement, in accordance with Schedule SE?

Schedule SE suggests that the answer is YES.

Suppose that Joe has SIMPLE IRA and income from his business, after expenses, but before subtracting half of the self-employment tax, of $13,500. The “Publication 560 employer contribution” is .9235 × $13,500 × .03 = $374.02. This amount, plus the maximum deferral of $12,500, is equal to $12,874.02. Joe’s Schedule SE deduction for half the self-employment tax is .9235 × $13,500 × .153 × .5 = $953.74 and $13,500 – $953.74 = $12,546.26. Note that $12,874.02 is smaller than $13,500, but it is larger than $12,546.26.

Question: Is Joe’s maximum SIMPLE IRA deduction $12,546.26, rather than $12,874.02, because $13,500 goes in line 12 of Form 1040 as income for the business, $953.74 goes in line 27 as a deduction and the net of $12,546.26 is part of adjusted gross income in line 37, and, because one’s retirement plan deduction cannot exceed his business income?

The online retirement plan calculators are of no help. They use 3/103, rather than .03 as the rate for the employer contribution for the owner-employee in a SIMPLE IRA.