Self Employment Taxes

Self-employment tax generally refers to contributions a self-employed person must make to social security and Medicare. Because self-employed taxpayers do not have withholding on their income, payment of the SE tax is usually made by quarterly payments through the estimated tax method.

Anyone who has net earnings from self-employment of $400.00 or more or any church employee who’s income exceeds $108.28 must pay the SE tax and file Schedule SE (Form 1040).

A taxpayer is considered self-employed if any of the following apply:

  1. Taxpayer carries on a trade or business as a sole proprietor or an independent contractor.
  2. Taxpayer is a member of a partnership that carries on a trade or business.
  3. Taxpayer is otherwise in business for herself

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. Taxpayer does not need to actually make a profit to be in a trade or business as long as she has a profit motive. Taxpayer does need, however, to make ongoing efforts to further the interests of his business.

Part-time business

Taxpayer does not have to carry on regular full-time business activities to be self-employed. Having a part-time business in addition to her regular job or business may also be self-employment.

Example: Taxpayer is employed full time as an engineer at the local plant. She fixes televisions and radios during the weekends. She has her own shop, equipment and tools. She gets her customers from advertising and word-of-mouth. She is self-employed as the owner of a part-time repair shop.

Sole proprietor

Taxpayer is a sole proprietor if she owns an unincorporated business by herself.

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.

The taxpayer is not an independent contractor if he performs services that can be controlled by an employer (i.e., what will be done and how it will be done). This applies even if he is 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), the taxpayer is not an independent contractor and his earnings are generally not subject to SE tax. Rather, the employer is responsible for that portion of the social security and Medicare contributions. However, his earnings as an employee may be subject to SE tax under other rules discussed in this section.

Do not assume that an individual who is treated as an independent contractor is not an employee. Some employers treat individuals as independent contractors instead of employees to avoid being liable for part of the employee’s social security contributions. As a general rule, whether an individual will properly be treated as an independent contractor or as an employee will be influenced by the degree of control that the individual has over the functions he performs to accomplish his assignment.

Other factors also bear on the determination. Because an independent contractor will not have income tax or social security taxes withheld, an independent contractor is responsible for making these tax payments. An individual paid as an independent contractor is often not prepared for the consequences of having to pay taxes herself. This often results in an underpayment for the period in which the individual worked as an independent contractor.

Resources

Internal Revenue Code

IRC §1401, Tax on Self-Employment Income
IRC §1402, Definitions

Treasury Regulations

Treas. Reg. §1.1401-1, Tax on self-employment income
Treas. Reg. §1.1402(a)-1, Definition of net earnings from self-employment
Treas. Reg. §1.1402(b)-1, Self-employment income
Treas. Reg. §1.1402(d)-1, Employee and wages

IRS Forms and Publications

IRS Form 1040 Schedule SE
IRS Publication 15-A, Employer’s Supplemental Tax Guide to distinguish between Independent Contractor and Employee
IRS Publication 533, Self-Employment Tax