General Information

Social security benefits.   Social security coverage provides you with retirement benefits, disability benefits, survivor benefits, and hospital insurance (Medicare) benefits. Your payments of self-employment tax (SE tax) help pay for your coverage under the social security system. Social security benefits are available to self-employed persons just as they are to wage earners.

How to become insured under social security.   You must be insured under the social security system before you begin receiving social security benefits. You are insured if you have the required number of credits (quarters of coverage). It does not matter whether the income is earned in one quarter or is spread over two or more quarters.

Earning credits in 2002.   You can earn a maximum of four credits per year. For 2002, you earn one credit for each $870 of income subject to social security taxes. You need $3,480 ($870 × 4) of self-employment income and wages to earn four credits in 2002.

For an explanation of the number of credits you must have to be insured and the benefits available to you and your family under the social security program, consult your nearest Social Security Administration (SSA) office.

Making false statements to get or to increase social security benefits may subject you to penalties.

How To Pay Self-Employment Tax

To pay SE 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, and
• Pay your SE tax using estimated tax.

An ITIN does not entitle you to social security benefits.

Obtaining a social security number.   If you never had an SSN, apply for one using Form SS-5. You can get this form at any Social Security office or by calling 1-800-772-1213.

You can also download Form SS-5 from the Social Security Administration web site at www.ssa.gov.

If you have a social security number from the time you were an employee, you must use that number. Do not apply for a new one.

Replacing a lost social security card.   If you have a number but lost your card, file Form SS-5. You will get a new card showing your original number, not a new number.

Name change.   If your name has changed since you received your social security card, complete Form SS-5 to report a name change.

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.

Paying estimated tax.   Estimated tax is the method used to pay tax (including SE tax) on income not subject to withholding. 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. Use Form 1040-ES, Estimated Tax for Individuals, to figure and pay the tax.

However, if at least two-thirds of your gross income in 2002 or 2003 is from farming and you file your Form 1040 and pay all the tax due by March 1, 2004, you do not have to pay any estimated tax for farmers. See chapter 2 for more information about estimated tax for farmers.

Penalty for underpayment of estimated tax.   You may have to pay a penalty if you do not pay enough estimated tax by its due date.

Social Security Administration (SSA) time limit for posting self-employment income.   Generally, the SSA will give you credit only for self-employment income reported on a tax return filed within 3 years, 3 months, and 15 days after the tax year you earned the income. If you file your tax return or report a change in your self-employment income after this time limit, the SSA may change its records, but only to remove or reduce the amount. The SSA will not change its records to increase your self-employment income.

Who Must Pay Self-Employment Tax?

You must pay SE tax and file Schedule SE (Form 1040) if your net earnings from self-employment were $400 or more.

Your net earnings from self-employment are based on your earnings subject to SE tax. Most earnings from self-employment are subject to SE tax. Some earnings from employment (certain earnings that are not subject to social security and Medicare taxes) are subject to SE tax. This section provides information to help you determine whether you have earnings subject to SE tax.

If you have earnings subject to SE tax, use Schedule SE to figure your net earnings from self-employment. Before you figure your net earnings, you generally need to figure your total earnings subject to SE tax. For more information, see Figuring Earnings Subject to SE Tax and Methods for Figuring Net Earnings, later.

The SE tax rules apply no matter how old you are and even if you are already receiving social security or Medicare benefits.

Are you self-employed?   You are self-employed if you carry on a trade or business (such as running a farm) as a sole proprietor, an independent contractor, or a member of a partnership or are otherwise in business for yourself. A trade or business is generally an activity carried on for a livelihood or in good faith to make a profit.

Share farmer.   You are a self-employed farmer under an income-sharing arrangement if both the following apply.

1. You produce a crop or raise livestock on land belonging to another person.
2. Your share of the crop or livestock, or the proceeds from their sale, depends on the amount produced.

Your income from the income-sharing arrangement is your SE income.

If you produce a crop or livestock on land belonging to another person and are to receive a specified rate of pay, a fixed sum of money, or a fixed quantity of the crop or livestock, and not a share of the crop or livestock or their proceeds, you may be either self-employed or an employee of the landowner. This will depend on whether the landlord has the right to direct or control your performance of service.

Example.   A share farmer produces a crop on land owned by another person on a 60-40 crop-share basis. Under the terms of their agreement, the share farmer furnishes the labor and half the cost of seed and fertilizer. The landowner furnishes the machinery and equipment used to produce and harvest the crop, and half the cost of seed and fertilizer. The share farmer is provided a house in which to live. The landowner and the share farmer decide how much of the tract should be planted in cotton and how much in other crops. In addition, the landowner is in the hog business and the share farmer agrees to take care of the landowner's hogs in return for ten hogs. The landowner furnishes the feed and other necessities and supervises the care of the hogs.

The share farmer is a self-employed farmer for purposes of the agreement to produce the cotton and other crops, and the share farmer's part of the income from the crops is SE income. The share farmer is an employee for the services performed in caring for the landowner's hogs. The fair market value of the ten hogs received is not SE income but it is taxable for income tax purposes. For more information, see Noncash wages in chapter 16.

4-H Club or FFA project.   If an individual participates in a 4-H Club or FFA project, any net income received from sales or prizes related to the project may be subject to income tax. Report the net income on line 21 of Form 1040. If necessary, attach a statement showing the gross income and expenses. The net income may not be subject to SE tax if the project is primarily for educational purposes and not for profit, and is completed by the individual under the rules and economic restrictions of the sponsoring 4-H or FFA organization. Such a project is generally not considered a trade or business.

Partnership income or loss.   If you are a member of a partnership that carries on a trade or business, the partnership should report your earnings subject to SE tax on line 15a of your Schedule K-1 (Form 1065). The partnership can use the worksheet in the form instructions to figure these earnings.

If you are a general partner, you may need to reduce these reported earnings by amounts you claim as a section 179 deduction, unreimbursed partnership expenses, or depletion on oil and gas properties.

If the amount reported is a loss, see the Partner's Instructions for Schedule K-1.

For general information on partnerships, see Publication 541.

Limited partner.   If you are a limited partner, your partnership earnings are generally not subject to SE tax. However, guaranteed payments you receive for services you perform for the partnership are subject to SE tax and should be reported to you on line 15a of your Schedule K-1.

Husband and wife partners.   You and your spouse may operate a farm as a partnership. (Partnerships are discussed in chapter 2.) If you and your spouse operate a farm as partners, report the farm income and expenses on Form 1065, and attach separate Schedules K-1 showing each partner's share of earnings. Each spouse must report his or her share of partnership earnings on Form 1040 and file separate Schedules SE (Form 1040) to report each spouse's SE tax.

However, if your spouse is your employee, not your partner, you must withhold and pay social security and Medicare taxes for him or her. For more information on employment taxes, see chapter 16.

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. 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 standing 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.
3. 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.
4. Wages paid in kind to you for agricultural labor, such as commodity wages, are not included in earnings subject to SE tax.
5. 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.

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