Because of the antipathy of American politicians to low-income people, who mostly don’t vote and mostly don’t make large campaign contributions, we’ve been blessed with a fractured and dysfunctional welfare state, designed to make income support as cumbersome and difficult as possible to receive, even or perhaps especially for those people who are, in fact, entitled to it.
One of the worst manifestations of that dysfunction is that programs have different, overlapping rules for eligibility: the earned income and child tax credits phase in, plateau, and then phase out, while the Supplemental Nutritional Assistance Program starts high and begins dropping almost immediately with each additional dollar of income you earn.
While this creates certain benefit cliffs, for example between eligibility for Medicaid and eligibility for Affordable Care Act exchange subsidies, it mostly just creates confusion: will an extra dollar of income increase your earned income credit by more or less than it decreases your SNAP benefit?
While employees may have little or no control over their annual income, and in fact may not even know their annual income in advance depending on how predictable their assigned hours are each week or month, people reporting self-employment income may be able to dial in their reported income to the dollar to maximize the available state and federal benefits.
While Jared Kushner has a team of lawyers and accountants working tirelessly to help him maximize the benefits of the tax code, you just have me. So here we go!
The four primary federal anti-poverty programs
Federal income support is composed of four primary programs, which I want to split up to make them easier to digest:
- Supplemental Nutrition Assistance Program (SNAP). Monthly benefits begin at $192 and increase by $161 for the second household member, $152 for the third, $137 for the fourth, and so on. For most beneficiaries (excluding those with unusually low housing and utility costs), benefits decrease by roughly $24 per month for every $100 in additional income you earn above roughly $900 per month. Unlike benefits administered through the tax code, the number used in SNAP benefit calculations is your net self-employment income before income or self-employment taxes are deducted. That means $900 in monthly self-employment income will pass through to your 1040 as $10,800 in business income, from which you’ll deduct $763 in self-employment taxes, resulting in $10,037 in adjusted gross income.
- Earned income credit. The EIC is one of the original “trapezoid programs,” with a rapid phase-in, a benefit plateau, then a gradual phase-out. The EIC is maximized for single childless filers with “earned income” between $6,650 and $8,350, for married childless filers between $6,650 and $13,950, for couples with one child between $10,000 and $18,350, and for couples with two or more children between $14,000 and $18,350. Every additional $100 in self-employment income in the phase-out period reduces childless filers’ EIC by $7.11, filers with one child by $14.85, and those with two children by $19.57. Note that for the self-employed, earned income is calculated based on your net self-employment income after deducting half your self-employment taxes.
Let’s take a breather here and consider how you would maximize your benefits if these were the only two federal income support programs, since we’ll have more moving pieces later.
Childless adults, whether single or married, have an incentive to absolutely minimize their reported earnings, while remaining eligible for SNAP. This is because the earned income credit phases in too slowly for these filers: an additional $100 of self-employment income increases their self-employment taxes by $14.13, while increasing their earned income credit by just $7.11. Since SNAP benefits begin to phase out at $10,800 in self-employment income, single childless filers are best off keeping their reported earnings below that level, since each additional dollar they earn costs them more in taxes than the amount they receive in income support.
The picture is different for filers with one child: here, the optimal self-employment income is $10,760 for married couples with one child, producing earned income of $10,000. Why? Because for filers with children, the earned income credit phases in faster than SNAP benefits are phased out. Each $100 in additional self-employment income increases the EIC by $31.60, while reducing SNAP benefits by just $2 and increasing taxes by $14.13, leaving such filers with $15.47 more disposable income.
The same logic would apply to married couples with two children: maximizing SNAP benefits requires $10,800 in self-employment income, while maximizing the EIC requires $15,064 in self-employment income. Again, we need to compare three values: the phase-in rate of the EIC, the phase-out rate of SNAP, and the marginal tax rate: $100 of additional self-employment income increases the EIC by $37.57, decreases SNAP by $2; and increases self-employment taxes by $14.13, leaving you with $21.44 more in disposable income.
Since $100 of additional self-employment income increases disposable income by $21.44, the optimal amount of self-employment income is the EIC-maximizing value of $15,064. Reporting income above that point decreases SNAP benefits and increases self-employment taxes without generating any additional benefits.
Simple enough? Unfortunately, we’ve still got two more anti-poverty programs to go.
- The reformed 2018 child tax credit is another trapezoid program for households with children. Families can begin claiming the credit when their self-employment income reaches $2,690, and each $100 in self-employment income above that level produces a credit of $13.94 per child, up to a maximum credit of $1,400 per child when self-employment income reaches $12,732.
- Medicaid is the final keystone of the American welfare state, and there are very important income restrictions to keep in mind, depending on your state. In Medicaid expansion states, virtually all low-income people are eligible for Medicaid, while in most non-expansion states, most self-employed people are not eligible (Wisconsin is an exception, since they did not expand Medicaid but reached an agreement with the federal government to extend exchange subsidies to the Medicaid-expansion population). Since the Affordable Care Act was designed to make Medicaid expansion universal, in most non-expansion states households aren’t eligible for subsidies on the private health exchanges until their income reaches 139% of the federal poverty line, based on household size. That means if you live in a Medicaid-expansion state, you need to keep your income below that threshold to qualify for Medicaid, while if you live in a non-expansion state, you need to make sure your income is above that level to qualify for the maximum ACA subsidy.
The child tax credit doesn’t affect our calculation for married couples with one child, since each additional $100 in self-employment income above $10,760 will increase their self-employment taxes by $14.13 and decrease their SNAP benefits by $2, while only increasing their child tax credit by $13.94 and leaving the earned income credit flat, leaving them with $2.19 less in disposable income.
In the case of a married couple with two children, however, we see $100 in increased self-employment income raising the child tax credit by $27.88, and the earned income by $37.17, swamping the $16.13 in increased taxes and lost benefits. That means the optimal self-employment income for married couples with two children rises all the way to the EIC-maximizing value of $15,064, at which point their total federal picture will be:
- $2,800 child tax credit;
- $5,616 earned income credit;
- $6,708 SNAP benefit;
- while paying $2,142 in self-employment taxes.
Their next $100 earned above this point will increase their self-employment taxes by $14.13 and decrease their SNAP benefits by $2, but have no effect on their child tax credit or earned income credit, leaving them with an effective marginal income tax rate of 16.13%.
So there you have it. If you have complete control over the amount of self-employment income you report each year, the amounts that optimize your federal income support benefits are:
- For childless adults (single or married): $10,800 or less. SNAP is the primary income support benefit for these households, so be sure to report 20 or more hours of self-employment per week.
- For parents of one child: $10,760. The EIC phases in more quickly than SNAP phases out, so your decreased food-only SNAP benefits are offset by a higher and more flexible EIC. Above that level, the increased child tax credit doesn’t fully offset your higher taxes and lower SNAP benefits.
- For parents of two children: $15,064. At this level, the EIC and child tax credit are both fully phased in, so any earnings above this point increase your taxes and lower your SNAP benefits without providing any additional benefits.