The self-employment tax rules apply no matter how old you are and even if you are already receiving social security and Medicare benefits.
Who Must Pay Self-Employment Tax?
Generally, you must pay self-employment (SE) tax and file Schedule SE (Form 1040) if your net earnings from self-employment were $400 or more. Use Schedule SE to figure net earnings from self-employment.
Sole proprietor or independent contractor. If you are self-employed as a sole proprietor or independent contractor, use Schedule C or C-EZ (Form 1040) to figure your earnings subject to SE tax.
Self-employment (SE) tax rate. The SE tax rate on net earnings is 15.3% (12.4% social security tax plus 2.9% Medicate tax.)
Maximum earnings subject to self-employment tax. Only the first $90,000 of your combined wages, tips, and net earnings in 2005 is subject to any combination of the 12.4% social security part of SE tax, social security tax, or railroad retirement (tier 1) tax.
All of your combined wages, tips, and net earnings in 2005 are subject to any combination of the 2.9% Medicare part of SE tax, social security tax, or railroad retirement (tier 1) tax.
If your wages and tips are subject to either social security or railroad retirement (tier 1) tax, or both, and total at least $90,000, do not pay the 12.4% social security part of the SE tax on any of your net earnings. However, you must pay the 2.9% Medicare part of the SE tax on all your net earnings.
Special Rules and Exceptions
More Than One Business
If you have earnings subject to SE tax from more than one trade, business,
or profession, you must combine the net profit (or loss) from each to
determine your total earnings subject to SE tax. A loss from one business
reduces your profit from another business.
Community Property Income
If any of the income from a trade or business, other than a partnership, is
community property income under state law, it is included in the earnings
subject to SE tax of the spouse carrying on the trade or business.
Gain or Loss
Do not include in earnings subject to SE tax a gain or loss from the
disposition of property that is neither stock in trade nor held primarily
for sale to customers. It does not matter whether the disposition is a
sale, exchange, or an involuntary conversion.
Lost Income Payments
If you are self-employed and reduce or stop your business activities,
any payment you receive from insurance or other sources for the lost business
income is included in earnings subject to SE tax. If you are not working
when you receive the payment, it still relates to your business and is
included in earnings subject to SE tax, even though your business is temporarily inactive.
Methods for Figuring Net Earnings
There are three ways to figure your net earnings from self-employment.
The regular method
The nonfarm optional method
The farm optional method
You must use the regular method unless you are eligible to use one or both of the optional methods.
Why use an optional method?
You may want to use the optional methods (discussed later) when you have a loss
or a small net profit and any one of the following applies.
You want to receive credit for social security benefit coverage.
You incurred child or dependent care expenses for which you could claim a credit. (An optional method may increase your earned income, which could increase your credit.)
You are entitled to the earned income credit. (An optional method may increase your earned income, which could increase your credit.)
You are entitled to the additional child tax credit. (An optional method may increase your earned income, which could increase your credit.)
Effects of using an optional method.
Using an optional method could increase your SE tax. Paying more SE tax could
result in your getting higher benefits when you retire.
If you use either or both optional methods, you must figure and pay the SE tax due under these methods even if you would have had a smaller tax or no tax using the regular method.
The optional methods may be used only to figure your SE tax. To figure your income tax, include your actual earnings in gross income, regardless of which method you use to determine SE tax.
The Regular Method
Multiply your total earnings subject to SE tax by 92.35% (.9235) to get your net
earnings under the regular method. See Short Schedule SE, line 4, or
Long Schedule SE, line 4a.
Net earnings figured using the regular method are also called actual net earnings.
The farm optional method
Use the farm optional method only for earnings from a farming business. See Publication 225
for information about this method.
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.
Reporting Self-Employment Tax
Use Schedule SE (Form 1040) to figure and report your SE tax. Then enter the SE tax on line 58 of Form 1040 and attach Schedule SE to Form 1040.
Most taxpayers can use Section A-Short Schedule SE to figure their SE tax. However, certain taxpayers must use Section B-Long Schedule SE.
If you have to pay SE tax, you must file Form 1040 (with Schedule SE attached) even if you do not otherwise have to file a federal income tax return.
Joint return. If you file a joint return, you cannot file a joint Schedule SE. This is true whether one spouse or both spouses have earnings subject to SE tax. If both of you have earnings subject to SE tax, each of you must complete a separate Schedule SE. However, if one spouse uses the Short Schedule SE and the other spouse has to use the Long Schedule SE, both can use the same form. Attach both schedules to the joint return.
More than one business. If you have more than one trade or business, you must combine the net profit (or loss) from each business to figure your SE tax. A loss from one business will reduce your profit from another business. File one Schedule SE showing the earnings from self-employment, but file a separate Schedule C, C-EZ, or F for each business.
Example.
You are the sole proprietor of two separate businesses. You operate a restaurant that
made a net profit of $25,000. You also have a cabinetmaking business that had a
net loss of $500. You must file a Schedule C for the restaurant showing your
net profit of $25,000 and another Schedule C for the cabinetmaking business showing
your net loss of $500. You file Schedule SE showing total earnings subject to SE tax of $24,500.
Information courtesy of the Internal Revenue Service.
