OK, to wrap this up, I think there’s something wrong with how the IRS interpreted the new Making Work Pay Credit. And so let me just put out a basic example and end it.
Let’s say you’re overseas for all of 2009. You take the foreign earned income exclusion (FEIE), and you have this income:
$20,000 foreign earned income
$25,000 net self-employment income, earned overseas
(There will be a 15.3% SE tax on the $25,000, or $3,825, which MUST appear on your 1040, regardless of whether you take the FEIE.)
According to Schedule M instructions, the $20,000 goes on Line 1(a).
The $25,000 goes on Line 2(b).
The $45,000 (total of 20,000 plus 25,000) will go on Line 5(a) and carry down to Line 5(c). You will have a result in Line 8 of ZERO.
That Line 8 result shuts you out of the Making Work Pay Credit on Schedule M. According to Schedule M, you will have zero earned income in boxes 1(a) and 4, but in fact you had “net earnings from self-employment”, which IS “taken into account in computing taxable income” because you will owe that $3,825 that I mentioned above.
And again, from the other day, the rule in Section 36A defining “earned income” refers back to Section 32, and says:
‘(2) EARNED INCOME.—The term ‘earned income’ has the meaning given such term by section 32(c)(2), except that such term shall not include net earnings from self-employment which are not taken into account in computing taxable income.
(Remember again, from the other day, that Section 32 definition has two parts: the income you earn because somebody pays you for work, PLUS the amount that you generate through self-employment. Only the part about the earnings paid to you as an employee said anything about taking them out of gross income or being “includible” in gross income.)
So, in the Section 36A cite above, Congress is not saying:
“net income from self-employment, which–as you all know!–is not the kind of thing that’s taken into account when we’re computing taxable income!”
because that’s nonsense.
Self-employment income is very much a part of taxable income, as any person who works for him-or-herself can tell you.
So where does the earner in the example above get to include those earnings in the Schedule M scheme of things? Nowhere, right? Why not?
And probably what it is, is that the makers of Schedule M have the whole law wrong, because they don’t really understand the definition of “earned income”, like I was saying the other day. Somebody got sloppy, they knew the result they wanted because they thought they understood the new credit. Or maybe they thought that EIC takes foreign earned income out of the earned income calculation, when in fact EIC does not, but prohibits the FEIE takers from taking EIC at all.