Earned income as defined for Roth IRA and Self-Employment income

[seymore92]

I am trying to keep my earned income to as close as possible to $12000 this year to permit my spouse & I to contribute $6000 to each of our Roth IRAs.

Our W2 Box-1 Wages are $11430 and we have self-employment income gross receipts of $570 (no expenses). I thought since these values total $12000=$11430+$570 I'd be good to go.

Using TurboTax 2019 I see that since on the $570 there is an $80 self-employment tax, and therefore a Deduction for one-half of self-employment tax, I have a deduction of $40. Then TurboTax tells me I only have $11960 ($12000-$40) of Earned Income qualifying for my Roth IRA contributions.

I couldn't figure out where the IRS defines Earned Income as excluding the one-half of self-employment tax. Can any of the tax gurus enlighten me?

[MarkNYC]

I couldn't figure out where the IRS defines Earned Income as excluding the one-half of self-employment tax. Can any of the tax gurus enlighten me?

The definition you're seeking can be found in the "What is Compensation" section of IRS Publication 590-A. Finding the definition with the tax code itself requires a little digging, starting with Code Sections 401C-2 and 1402(a).

[seymore92]

I couldn't figure out where the IRS defines Earned Income as excluding the one-half of self-employment tax. Can any of the tax gurus enlighten me?

The definition you're seeking can be found in the "What is Compensation" section of IRS Publication 590-A. Finding the definition with the tax code itself requires a little digging, starting with Code Sections 401C-2 and 1402(a).

Thanks! Perfect. Quote from page 6 of pub 590-A with added emphasis

Self-employment income. If you are self-employed (a sole proprietor or a partner), compensation is the net earnings from your trade or business (provided your per- sonal services are a material income-producing factor) re-duced by the total of:
• The deduction for contributions made on your behalf to retirement plans, and
• The deduction allowed for the deductible part of your self-employment taxes.

[Spirit Rider]

As @retiredjg is wont to point out, it is compensation and not earned income that is the basis for IRA contributions. Compensation is always earned income, but earned income is not always compensation.

Note: Not that it helps you much because of how little self-employed earned income you have. However, there maybe someone reading the thread it will help. If you were to adopt a one-participant 401k plan at a provider that supports designated Roth contributions. Any Roth 401k contributions to your W-2 primary employer 401k and/or a one-participant 401k does not reduce your compensation available for IRA contributions.

With $12K in compensation, it is possible to contribute $12K to a Roth 401k* and $12K to your Roth IRAs.

*A self-employed individual could reach the maximum, but a W-2 employee would be limited by the employee share of FICA and section 125 deductions.

[seymore92]

As @retiredjg is wont to point out, it is compensation and not earned income that is the basis for IRA contributions. Compensation is always earned income, but earned income is not always compensation.

Thank you for this helpful insight. I like to be precise and now I’m better informed.

[seymore92]

Also, perhaps counterintuitively, I believe Jury Duty Pay is Other Taxable Income but not Compensation (and therefore also not Earned Income). This is deduced from entering in the Jury Duty Pay section in TurboTax and also a close reading of the What is Compensation section of Pub 590-A (pg. 6).