Who Pays Self-Employment Tax?
Taxpayers pay SE tax when earnings from self-employment are $400 or more. A taxpayer is self-employed if he or she carries on a trade or business as a sole proprietor (including farmers) or as a general partner in a partnership. A trade or business generally is an activity carried on for a livelihood or in good faith to make a profit.
Net profit is calculated by subtracting ordinary and necessary trade or business expenses from gross self-employment income. A taxpayer is self–employed for this purpose if they are a sole proprietor, an independent contractor, a member of a partnership, or are otherwise in business for themselves. A taxpayer can be liable for paying self–employment tax even if they are currently receiving social security benefits. Facts and circumstances determine whether or not an activity is a trade or business. A taxpayer does not actually have to make a profit to be a trade or business. For more detailed information on Self-Employment Tax, see Publication 334.
Claiming all deductions
Failing to claim all deductions related to self-employment violates the Self-Employment Contributions Act of 1954. The act requires every taxpayer to claim all of his or her allowable deductions, including depreciation, in computing net earnings from self-employment for SE tax purposes. Penalties apply for making a false statement or representation in connection with any matter arising under the act.
Self-Employment Tax Optional Methods
There are optional methods designed to give taxpayers credit for Social Security coverage in years when the taxpayer otherwise has a loss or small amount of income from self-employment. They may also be used to help taxpayers qualify for the earned income credit, the additional child tax credit, the child and dependent care credit, and the self-employed health insurance deduction.
A taxpayer who had a small profit or net loss from their business but wants to pay into the social security system may be eligible to use one of the two optional methods to compute their net earnings from self-employment.
- Farm optional method
- Nonfarm optional method
A taxpayer who is an employee of a church or qualified church-controlled organization that elected exemption from social security and Medicare taxes, and who is not exempt from self-employment tax, must pay self-employment tax if they are paid more than an amount specified by law in a year from the church or qualified church-controlled organization. If they are required to pay self-employment tax, they must attach Schedule SE to their Form 1040. For more information on church related income and self-employment taxes, see Publication 517.
Examples of kinds of workers, kinds of income or loss, and the relationship to self-employment tax
| Type of Worker | SE Tax Requirements |
| Employee | Not subject to SE tax, but is subject to FICA withholding. |
| Hobby income | Not subject to SE tax. |
| General partnerLimited partner | General partner: Guaranteed payments and distributive share of income are subject to SE tax.Limited partner: Only guaranteed payments are subject to SE tax. |
| LLC member | Treated like a limited partner unless one of these is true: (1) Has personal liability for the LLC’s debts, or (2) has authority to contract on behalf of the LLC, or (3) participates in LLC business more than 500 hours during the year. See Prop. Treas. Reg. 1.1402(a)-2(h). |
| Deceased general partner | Earnings from self-employment include the distributive share of partnership profits through the end of the month in which the partner died. |
| Retired partner | Lifelong periodic payments are not subject to SE tax if the partner had no other interest in the partnership and did not perform services for the partnership during the year. |
| S corporation shareholder | Distributive share of earnings are not subject to SE tax. Wages paid for services performed subject to FICA. |
| Share crop farming | Producing crops or livestock on someone else’s land for a share of the crops or livestock is subject to SE tax, as is the landlord’s income if he or she materially participates in the farm activity. |
| Department of Agriculture | Payments for participating in a land diversion program are subject to SE tax. |
| Community property states | State laws that say income is earned on-half by each spouse do not apply to SE tax. The spouse who actually earns the income is subject to SE tax. |
| Covenant not to compete | Not subject to SE tax. |
| Insurance agent (self-employed) | Subject to SE tax on regular, renewal, and deferred commissions, if earned prior to retirement. Exception: Covenant not to compete. |
| Rental real estate | Not subject to SE tax unless substantial services are provided, such as a hotel or tourist camp. |
| Newspaper and magazine sales | Under age 18, exempt from SE tax. Age 18 or older, subject to SE tax. |
| Notary public | Exempt from SE tax. Enter “Exempt-Notary” on SE tax line of Form 1040. |
| Interest on accounts receivable | Subject to SE tax if received in the course of trade or business. Not subject to SE tax if the security is held as an investment. |
| Net operating loss | Carryovers from other years do not reduce current year earnings for SE tax calculation purposes. |
| Fishing vessel crew members | Subject to SE tax if compensation based on share of catch and average crew size is less than 10. Crews of 10 or more are considered employees. |
| Corporate director fees | Subject to SE tax. |
| Estate fiduciary fees | Not subject to SE tax unless taxpayer is a professional fiduciary or an active participant in the estate’s trade or business. |
| Depreciation recapture | Not subject to SE tax unless it is due to the business use of Section 179 or 280F property falling to 50% or less. |
| Church employees (other than a minister or religious order member) | Must pay SE tax on wages of $108.28 or more if employer has a certificate in effect electing an exemption from employee Social Security and Medicare taxes. |
| Ministers and members of a religious order | Pay SE tax on salaries and other income for services performed as an ordained, commissioned, or licensed minister, member of a religious order, or a Christian Science practitioner. Housing allowance income may be subject to SE tax. Exceptions: A minister or Christian Science practitioner can apply for exemption from SE tax by filing Form 4361. A member of a recognized religious group can file for and exemption from SE tax if he or she is conscientiously opposed to accepting Social Security or Medicare benefits, by filing Form 4029. Services performed by a member of a religious order who has taken a vow of poverty is exempt from SE tax. |
| U.S. citizen employed by a foreign government | Subject to SE tax only if the services are performed in the U.S., Puerto Rico, Guam, American Samoa, the Commonwealth of the Northern Mariana Islands, or the Virgin Islands. |
| Foreign earned income | U.S. citizens living and working outside the U.S. are subject to SE tax on SE earnings, unless the U.S. has a Social Security exemption agreement with the foreign country. The foreign earned income exclusion for income tax purposes does not apply to SE tax. |
| State and local government employees | Certain fee basis government employees not covered under a Social Security agreement may be subject to SE tax. |
Wrong Treatment of Employees as Independent Contractors
If an taxpayer is receives a Form 1099-MISC from the individual or firm for whom they worked, i.e., they are being treated as an independent contractor, but the taxpayer believes they should be treated as an employee, they have two choices:
- Consider themselves to be self-employed, file Schedule C or Schedule F as appropriate, along with Schedule SE, and pay self-employment (SE) tax on the earnings, or
- File Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and
Income Tax Withholding, after which the IRS will determine if the worker should have been treated as an employee, along with tax withholding and paying one-half of the employee’s FICA.
NOTE: This is a guide on entering Schedule SE into the Keystone Tax Solutions program. This is not intended as tax advice. For additional information refer to the Additional Information below.
Additional Information:
Minister / Clergy Member Tax Return
IRS: Instructions for Schedule SE (Form 1040), Self-Employment Tax
IRS: Instructions for Schedule C, Profit or Loss From Business
IRS: Instructions for Schedule F, Profit or Loss From Farming