TAX NEWS - June 2010
Self-Employment Tax
- What is Self-Employment Tax?
- How to Pay Self-Employment Tax
- Estimated Taxes
- Who Must Pay Self-Employment Tax?
- Are You Self-Employed?
- Earned Income Tax Credit
- Family Caregivers and Self-Employment Tax
What is Self-Employment Tax?
Self-employment tax (SE tax) is a social security and Medicare tax primarily for individuals who work for themselves. It is similar to the social security and Medicare taxes withheld from the pay of most wage earners.
You figure self-employment tax yourself using Schedule SE (Form 1040). Social security and Medicare taxes of most wage earners are figured by their employers. Also you can deduct half of your SE tax in figuring your adjusted gross income. Wage earners cannot deduct social security and Medicare taxes.
Self-employment tax rate. The self-employment tax rate is 15.3%. The rate consists of two parts: 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).
Maximum earnings subject to self-employment tax. Only the first $106,800 of your combined wages, tips, and net earnings in 2009 is subject to any combination of the 12.4% social security part of self-employment tax, social security tax, or railroad retirement (tier 1) tax.
All your combined wages, tips, and net earnings in 2009 are subject to any combination of the 2.9% Medicare part of self-employment tax, social security tax, or railroad retirement (tier 1) tax.
Fiscal year filer. If you use a tax year other than the calendar year, you must use the tax rate and maximum earnings limit in effect at the beginning of your tax year. Even if the tax rate or maximum earnings limit changes during your tax year, continue to use the same rate and limit throughout your tax year.
Self-employment tax deduction. You can deduct half of your self-employment tax in figuring your adjusted gross income. This deduction only affects your income tax. It does not affect either your net earnings from self-employment or your SE tax.
How to Pay Self-Employment Tax
To pay self-employment tax, you must have a social security number (SSN) or an individual taxpayer identification number (ITIN). This section explains how to:
- Obtain an SSN or ITIN
- Pay your self-employment tax using estimated tax.
Obtaining a Social Security Number. If you never had an SSN, apply for one using Form SS-5, Application for a Social Security Card. You can get this form at any Social Security office or by calling (800) 772-1213. Download the form from the Social Security Online Web site.
Obtaining an Individual Taxpayer Identification Number. The IRS will issue you an ITIN if you are a nonresident or resident alien and you do not have and are not eligible to get an SSN. To apply for an ITIN , file Form W-7, Application for IRS Individual Taxpayer Identification Number.
Estimated Taxes
Federal income tax is a pay-as-you-go tax. You must pay the tax as you earn or receive income during the year. You generally have to make estimated tax payments if you expect to owe tax, including self-employment tax, of $1,000 or more when you file your return. There are two ways to pay as you go: withholding and estimated taxes. If you are a self-employed individual and do not have income tax withheld, you must make estimated tax payments.
Who Must Pay Self-Employment Tax?
You must pay self-employment tax and file Schedule SE (Form 1040) if either of the following applies.
- Your net earnings from self-employment (excluding church employee income ) were $400 or more.
- You had church employee income of $108.28 or more.
Your net earnings from self-employment are based on your earnings subject to self-employment tax. Most earnings from self-employment are subject to self-employment tax. Some earnings from employment (certain earnings that are not subject to social security and Medicare taxes) are subject to self-employment tax.
If you have earnings subject to self-employment tax, use Schedule self-employment to figure your net earnings from self-employment . Before you figure your net earnings, you generally need to figure your total earnings subject to self-employment tax.
Note: The self-employment tax rules apply no matter how old you are and even if you are already receiving social Security or Medicare.
Are You Self-Employed?
You are self-employed if any of the following apply to you.
- You carry on a trade or business as a sole proprietor or an independent contractor.
- You are a member of a partnership that carries on a trade or business.
- You are otherwise in business for yourself.
Trade or business. A trade or business is generally an activity carried on for a livelihood or in good faith to make a profit. The facts and circumstances of each case determine whether or not an activity is a trade or business. The regularity of activities and transactions and the production of income are important elements. You do not need to actually make a profit to be in a trade or business as long as you have a profit motive. You do need, however, to make ongoing efforts to further the interests of your business.
Part-time business. You do not have to carry on regular full-time business activities to be self-employed. Having a part-time business in addition to your regular job or business also may be self-employment.
Example. You are employed full time as an engineer at the local plant. You fix televisions and radios during the weekends. You have your own shop, equipment, and tools. You get your customers from advertising and word-of-mouth. You are self-employed as the owner of a part-time repair shop.
Sole proprietor. You are a sole proprietor if you own an unincorporated business by yourself, in most cases. However, if you are the sole member of a domestic limited liability company (LLC), you are not a sole proprietor if you elect to treat the LLC as a corporation. For more information on this election and the tax treatment of a foreign LLC, see Form 8832, Entity Classification Election.
Independent contractor. People such as doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers, or auctioneers who are in an independent trade, business, or profession in which they offer their services to the general public are generally independent contractors. However, whether these people are independent contractors or employees depends on the facts in each case. The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. The earnings of a person who is working as an independent contractor are subject to SE tax.
You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done). This applies even if you are given freedom of action. What matters is that the employer has the legal right to control the details of how the services are performed.
If an employer-employee relationship exists (regardless of what the relationship is called), you are not an independent contractor and your earnings are generally not subject to SE tax. However, your earnings as an employee may be subject to SE tax under other rules discussed in this section.
For more information on determining whether you are an independent contractor or an employee, refer to the section on Independent Contractors vs. Employees
Earned Income Tax Credit
If you file a Form 1040 Schedule C, you may be eligible to claim the Earned Income Tax Credit (EITC). Learn more about EITC, or use the EITC Assistant to find out if you are eligible.
Family Caregivers and Self-Employment Tax
Special rules apply to workers who perform in-home services for elderly or disabled individuals (caregivers). Caregivers are typically employees of the individuals for whom they provide services because they work in the homes of the elderly or disabled individuals and these individuals have the right to tell the caregivers what needs to be done. These services may or may not be provided by a family member. If the caregiver employee is a family member, the employer may not owe employment taxes even though the employer needs to report the caregiver's compensation on a Form W-2. See Pub 926 for more information. However, in some cases the caregivers are not employees. In such cases, the caregiver must still report the compensation as income of his or her Form 1040, and may be required to pay self-employment tax depending on the facts and circumstances.
The following FAQs illustrate some fact patterns involving family member caregivers who are not employees.
Q 1: Must a taxpayer pay self-employment tax on the income she received from an insurance company to care for her spouse who was injured in an accident and permanently disabled? The taxpayer is caring for her spouse in their home in an effort to avoid moving him to a nursing facility and also to reduce care giving costs. The spouse requires assistance with dressing, bathing, eating, etc; the taxpayer also administers medication and helps with basic physical therapy. Taxpayer is neither a trained nurse nor therapist and doesn't provide such services to anyone other than her spouse. Taxpayer received Form 1099-MISC from the insurance company with the amount paid shown in Box 7 as nonemployee compensation.
A 1: No, the taxpayer does not owe self-employment tax on amounts reported on the 1099-MISC she received from the insurance company if she is not engaged in a trade or business of providing care giving services, as appears to be the case in this situation. The taxpayer must report the full amount of the payment on line 17 of Form 1040 as other income.
Q 2: Must a taxpayer pay self-employment tax on the income received from a state agency to care for his grandchildren so that his daughter can work? Taxpayer doesn't have a day care business or look after any other children. Taxpayer receives Form 1099-MISC from the state agency with the amount paid shown in Box 7 as nonemployee compensation.
A 2: No, the taxpayer does not owe self employment tax on amounts reported on the 1099-MISC he received from the state agency if he is not engaged in a trade or business of providing day care services, as appears to be the case in this situation. The taxpayer must report the full amount of the payment on line 17 of Form 1040 as other income.
Q 3: Must a taxpayer pay self-employment tax on the income received from a state agency to care for her grandmother if the taxpayer operates a sole proprietorship adult day-care business for multiple clients, including her grandmother, in her home? The state agency pays for the care so that the grandmother need not be institutionalized. Taxpayer receives Form 1099-MISC from the state agency with the amount paid shown in Box 7 as nonemployee compensation.
A 3: Yes, the taxpayer owes self-employment tax since the taxpayer is engaged in a trade or business of providing care giving services as a sole proprietor operator of an adult day care. The taxpayer must report the full amount of the payment as income on both Schedule C and Schedule SE.
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