Figuring Earnings Subject to
Self-Employment Tax

Generally, you need to figure your total earnings subject to SE tax before you can figure your net earnings from self-employment. This section will help you figure these total earnings. If you are a self-employed farmer, use Schedule F (Form 1040) to figure your earnings subject to SE tax.

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 net earnings subject to SE tax. A loss from one business reduces your profit from another business.

Various types of income included in earnings subject to SE tax are discussed next. The list is not all inclusive.

1. Taxable patronage dividends (distributions) from cooperatives.
2. Government agricultural program payments, including commodity program payments and conservation reserve program (CRP) payments. (If you do not materially participate in farming operations on the land, the CRP payment is not included in earnings subject to SE tax.)
3. Taxable Commodity Credit Corporation loans.
4. Refunds and rebates, if they represent a reduction in a deductible expense item, including a fuel tax credit included in income.
5. Prizes or awards on farm produce or livestock.
6. Crop damage payments.
7. Value of property and services received for farm products.
8. Sales of unharvested crops, if not sold with land that was held more than 1 year.
9. Rent you receive if you meet one of the four material participation tests explained later under Landlord Participation in Farming.

   If you receive the rent as crop shares, you must meet the test at the time the crop shares are produced. However, the crop shares are included in earnings subject to SE tax in the year they are converted to money or the equivalent of money.

10. Any amounts for depreciation, including any section 179 deduction, recaptured because the business use of the property was reduced to 50% or less. This does not include amounts recaptured on the disposition of property.
11. Lost income payments received from insurance or other sources for reducing or stopping farming activities. These include USDA payments to compensate for lost income resulting from reductions in tobacco quotas and allotments. Even if you are not farming when you receive the payment, it is included in earnings subject to SE tax if it relates to your farm business (even though it is temporarily inactive). A connection exists if it is clear the payment would not have been made but for your conduct of your farm business.

Income not included in earnings subject to SE tax. Certain kinds of income are not included in earnings subject to SE tax, even though they are included when figuring your income tax.

1. Rental income you receive from real estate and from personal property leased with real estate is not included in earnings subject to SE tax. It does not matter if the rent is received in crop shares, cash, or other property. This rule applies only if the landlord does not materially participate in the production or management of production of farm products on the land. If the landlord materially participates, see Landlord Participation in Farming, later.
2. Interest is not included in earnings subject to SE tax unless you receive it in your trade or business, such as interest on accounts receivable.
3. Dividends on securities you own are not included in earnings subject to SE tax unless you are a dealer in securities who is not holding the securities for speculation or investment.
4. A gain or loss from the disposition of property that is neither stock in trade nor held primarily for sale to customers is not included in earnings subject to SE tax. It does not matter whether the disposition is a sale, exchange, or involuntary conversion. For example, gains or losses from the disposition of the following types of property are not included in earnings subject to SE tax.
1. Investment property.
2. Depreciable property or other fixed assets used in your trade or business.
3. Livestock held for draft, breeding, sport, or dairy purposes, and not held primarily for sale, regardless of how long the livestock was held, or whether it was raised or purchased.
4. Unharvested crops sold with land held more than one year.
5. Timber, coal, or iron ore held for more than one year if an economic interest was retained, such as a right to receive coal royalties.

   A gain or loss from the cutting of timber is not included in earnings subject to SE tax if the cutting is treated as a sale or exchange.

5. Wages and salaries received for services performed as an employee and covered by social security or railroad retirement are not included in earnings subject to SE tax.
6. Wages paid in kind to you for agricultural labor, such as commodity wages, are not included in earnings subject to SE tax.
7. Retirement income received by a partner from his or her partnership under a written plan is not included in earnings subject to SE tax if all the following apply.
1. The retired partner performs no services for the partnership during the year.
2. The retired partner is owed only the retirement payments.
3. The retired partner's share (if any) of the partnership capital was fully paid to the retired partner.
4. The payments to the retired partner are lifelong, periodic payments.

Landlord Participation in Farming

As a general rule, income and deductions from rentals and from personal property leased with real estate are not included in determining earnings subject to SE tax. However, income and deductions from farm rentals, including government commodity program payments received by a landowner who rents land, are included if the rental arrangement provides that the landlord will, and does, materially participate in the production or management of production of the farm products on the land.

Crop shares. Rent paid in the form of crop shares is included in earnings subject to SE tax for the year you sell, exchange, give away, or use the crop shares if you meet one of the four material participation tests (discussed next) at the time the crop shares are produced. Feeding such crop shares to livestock is considered using them. Your gross income for figuring your earnings subject to SE tax under the Farm Optional Method includes the fair market value of the crop shares when they are used as feed.

Material participation. You materially participate if you have an arrangement with your tenant for your participation and you meet one of the following tests.

1. You do any three of the following.
1. Pay, using cash or credit, at least half the direct costs of producing the crop or livestock.
2. Furnish at least half the tools, equipment, and livestock used in the production activities.
3. Advise or consult with your tenant.
4. Inspect the production activities periodically.
2. You regularly and frequently make, or take an important part in making, management decisions substantially contributing to or affecting the success of the enterprise.
3. You work 100 hours or more spread over a period of 5 weeks or more in activities connected with agricultural production.
4. You do things that, considered in their totality, show you are materially and significantly involved in the production of the farm commodities.

These tests may be used as general guides for determining whether you are a material participant.

Example. Drew Houston agrees to produce a crop on J. Clarke's cotton farm with each receiving half the proceeds. Clarke furnishes all the necessary equipment and advises Houston when to plant, to chop, plow, spray, and pick the cotton. During the growing season, Clarke inspects the crop every few days to determine whether Houston is properly taking care of the crop. Houston furnishes all labor needed to grow and harvest the crop.

The management decisions made by J. Clarke in connection with the care of the cotton crop and his regular inspection of the crop, along with all the necessary equipment he furnishes, establish that he participates to a material degree in the cotton production operations. The income Clarke receives from his cotton farm is included in computing his net earnings from self-employment.

Previous| First | Next

Publication Index | IRS-Forms Main | Home