These funds were received by your business and not you personally.
The 1099-G income belongs on the Schedule C as other income (not general income where you saw those prompts) and IS subject to self-employment taxes. The unrestricted use of these funds means that if used properly you would also have corresponding expenses spent from these funds.
Therefore, the recording of the 1099-G in its proper Other Income category, satisfies the reporting to the IRS on the 1099-G form, and the reporting of expenditures with grant funds in the expense section will negate any self-employment taxes on this income. You will have a wash in other words.
What would be wrong is to report fund expenditures as expenses, and thus lower your self-employment taxes falsely without the corresponding grant income. @dbookbinder
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