| Pub. 334, Tax Guide for Small Business |
2005 Tax Year |
10.
Self-Employment (SE) Tax
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
Aliens.
Resident aliens are generally subject to the same rules that apply to U.S. citizens. Nonresident aliens are not subject
to SE tax. Residents of the
Virgin Islands, Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, or American Samoa, however, are subject
to the tax. For SE tax
purposes, they are not nonresident aliens. For more information on aliens, see Publication 519, U.S. Tax Guide for Aliens.
Church employee.
If you work for a church or a qualified church-controlled organization (other than as a minister or member of a religious
order) that elected an
exemption from social security and Medicare taxes, you are subject to SE tax if you receive $108.28 or more in wages from
the church or organization.
For more information, see Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers.
Fishing crew member.
If you are a member of the crew on a boat that catches fish or other water life, your earnings are subject to SE tax
if all the following
conditions apply.
-
You do not get any pay for the work except your share of the catch or a share of the proceeds from the sale of the catch,
unless the pay
meets all the following conditions.
-
The pay is not more than $100 per trip.
-
The pay is received only if there is a minimum catch.
-
The pay is solely for additional duties (such as mate, engineer, or cook) for which additional cash pay is traditional in
the fishing
industry.
-
You get a share of the catch or a share of the proceeds from the sale of the catch.
-
Your share depends on the amount of the catch.
-
The boat's operating crew normally numbers fewer than 10 individuals. (An operating crew is considered as normally made up
of fewer than 10
if the average size of the crew on trips made during the last four calendar quarters is fewer than 10.)
You are not subject to SE tax if you are under age 18 and you are working for your father or mother.
Notary public.
Fees you receive for services you perform as a notary public are reported on Schedule C or C-EZ but are not subject
to self-employment tax (see the
Instructions for Schedule SE (Form 1040)).
State or local government employee.
You are subject to SE tax if you are an employee of a state or local government, are paid solely on a fee basis, and
your services are not covered
under a federal-state social security agreement.
Foreign government or international organization employee.
You are subject to SE tax if both the following conditions are true.
-
You are a U.S. citizen employed in the United States, Puerto Rico, Guam, American Samoa, the Commonwealth of the Northern
Mariana Islands,
or the Virgin Islands by:
-
A foreign government,
-
A wholly-owned instrumentality of a foreign government, or
-
An international organization.
-
Your employer is not required to withhold social security and Medicare taxes from your wages.
U.S. citizen or resident alien residing abroad.
If you are a self-employed U.S. citizen or resident alien living outside the United States, in most cases you must
pay SE tax. Do not reduce your
foreign earnings from self-employment by your foreign earned income exclusion.
Exception.
The United States has social security agreements with many countries to eliminate double taxation under two social
security systems. Under these
agreements, you generally must only pay social security and Medicare taxes to the country you live in. The country to which
you must pay the tax will
issue a certificate which serves as proof of exemption from social security tax in the other country.
See the Instructions for Schedule SE (Form 1040) for more information.
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.
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.
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.
Figuring Earnings Subject to Self-Employment (SE) Tax
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.
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.
Use the nonfarm optional method only for earnings that do not come from farming. You may use this method if you meet all the
following tests.
-
You are self-employed on a regular basis. This means that your actual net earnings from self-employment were $400 or more
in at least 2 of
the 3 tax years before the one for which you use this method. The net earnings can be from either farm or nonfarm earnings
or both.
-
You have used this method less than 5 years. (There is a 5-year lifetime limit.) The years do not have to be one after another.
-
Your net nonfarm profits were:
-
Less than $1,733, and
-
Less than 72.189% of your gross nonfarm income.
Net nonfarm profits.
Net nonfarm profit generally is the total of the amounts from:
-
Line 31, Schedule C (Form 1040),
-
Line 3, Schedule C-EZ (Form 1040),
-
Box 14, code A, Schedule K-1 (Form 1065), (from nonfarm partnerships), and
-
Box 9, code K1, Schedule K-1 (Form 1065-B).
However, you may need to adjust the amount reported on Schedule K-1 if you are a general partner or if it is a loss.
Gross nonfarm income.
Your gross nonfarm income generally is the total of the amounts from:
-
Line 7, Schedule C (Form 1040),
-
Line 1, Schedule C-EZ (Form 1040),
-
Box 14, code C, Schedule K-1 (Form 1065) (from nonfarm partnerships), and
-
Box 9, code K2, Schedule K-2 (Form 1065-B).
Figuring Nonfarm Net Earnings
If you meet the three tests explained earlier, use the following table to figure your net earnings from self-employment under
the nonfarm optional
method.
Table 10-1. Figuring Nonfarm Net Earnings
|
IF your gross nonfarm income is ...
|
THEN your net earnings are equal to ...
|
|
$2,400 or less
|
Two-thirds of your gross nonfarm income.
|
|
More than $2,400
|
$1,600
|
Actual net earnings.
Your actual net earnings are 92.35% of your total earnings subject to SE tax (that is, multiply total earnings subject
to SE tax by 92.35% (.9235)
to get actual net earnings). Actual net earnings are equivalent to net earnings figured using the regular method.
Optional net earnings less than actual net earnings.
You cannot use this method to report an amount less than your actual net earnings from self-employment.
Gross nonfarm income of $2,400 or less.
The following examples illustrate how to figure net earnings when gross nonfarm income is $2,400 or less.
Example 1. Net nonfarm profit less than $1,733 and less than 72.189% of gross nonfarm income.
Ann Green runs a craft business. Her actual net earnings from self-employment were $800 in 2003 and $900 in 2004. She meets
the test for being
self-employed on a regular basis. She has used the nonfarm optional method less than 5 years. Her gross income and net profit
in 2005 are as follows:
Ann's actual net earnings for 2005 are $1,108 ($1,200 × .9235). Because her net profit is less than $1,733 and less than 72.189%
of her gross
income, she can use the nonfarm optional method to figure net earnings of $1,400 (⅔ × $2,100). Because these net earnings
are
higher than her actual net earnings, she can report net earnings of $1,400 for 2005.
Example 2. Net nonfarm profit less than $1,733 but not less than 72.189% of gross nonfarm income.
Assume that in Example 1 Ann's gross income is $1,000 and her net profit is $800. She must use the regular method to figure
her net earnings. She
cannot use the nonfarm optional method because her net profit is not less than 72.189% of her gross income.
Example 3. Net loss from a nonfarm business.
Assume that in Example 1 Ann has a net loss of $700. She can use the nonfarm optional method and report $1,400 (⅔ × $2,100)
as
her net earnings.
Example 4. Nonfarm net earnings less than $400.
Assume that in Example 1 Ann has gross income of $525 and a net profit of $175. In this situation, she would not pay any SE
tax under either the
regular method or the nonfarm optional method because her net earnings under both methods are less than $400.
Gross nonfarm income of more than $2,400.
The following examples illustrate how to figure net earnings when gross nonfarm income is more than $2,400.
Example 1. Net nonfarm profit less than $1,733 and less than 72.189% of gross nonfarm income.
John White runs an appliance repair shop. His actual net earnings from self-employment were $10,500 in 2003 and $9,500 in
2004. He meets the test
for being self-employed on a regular basis. He has used the nonfarm optional method less than 5 years. His gross income and
net profit in 2005 are as
follows:
|
Gross nonfarm income
|
$12,000
|
|
Net nonfarm profit
|
$1,200
|
John's actual net earnings for 2005 are $1,108 ($1,200 × .9235). Because his net profit is less than $1,733 and less than
72.189% of his
gross income, he can use the nonfarm optional method to figure net earnings of $1,600. Because these net earnings are higher
than his actual net
earnings, he can report net earnings of $1,600 for 2005.
Example 2. Net nonfarm profit not less than $1,733.
Assume that in Example 1 John's net profit is $1,800. He must use the regular method. He cannot use the nonfarm optional method
because his net
nonfarm profit is not less than $1,733.
Example 3. Net loss from a nonfarm business.
Assume that in Example 1 John has a net loss of $700. He can use the nonfarm optional method and report $1,600 as his net
earnings from
self-employment.
Use the farm optional method only for earnings from a farming business. See Publication 225 for information about this method.
Using Both Optional Methods
If you have both farm and nonfarm earnings, you may be able to use both optional methods to determine your net earnings from
self-employment.
To figure your net earnings using both optional methods, you must:
-
Figure your farm and nonfarm net earnings separately under each method. Do not combine farm earnings with nonfarm earnings
to figure your
net earnings under either method.
-
Add the net earnings figured under each method to arrive at your total net earnings from self-employment.
You can report less than your total actual farm and nonfarm net earnings but not less than actual nonfarm net earnings. If
you use both
optional methods, you can report no more than $1,600 as your combined net earnings from self-employment.
Example.
You are a self-employed farmer. You also operate a retail grocery store. Your gross income, actual net earnings from self-employment,
and optional
farm and optional nonfarm net earnings from self-employment are shown in Table 10-2.
Table 10-2. Example—Farm and Nonfarm Earnings
|
Income and Earnings
|
Farm
|
Nonfarm
|
|
Gross income
|
$1,200
|
$1,500
|
|
Actual net earnings
|
$900
|
$500
|
|
Optional net earnings (⅔ of gross income)
|
$800
|
$1,000
|
Table 10-3 shows four methods or combinations of methods you can use to figure net earnings from self-employment using the
farm and nonfarm gross
income and actual net earnings shown in Table 5.
-
Method 1. Using the regular method for both farm and nonfarm income.
-
Method 2. Using the optional method for farm income and the regular method for nonfarm income.
-
Method 3. Using the regular method for farm income and the optional method for nonfarm income.
-
Method 4. Using the optional method for both farm and nonfarm income.
Note. Actual net earnings is the same as net earnings figured using the regular method.
Table 10-3. Example—Net Earnings
| Net Earnings |
1 |
2 |
3 |
4 |
Actual
farm
|
$ 900
|
|
$ 900
|
|
Optional
farm
|
|
$ 800
|
|
$ 800
|
Actual
nonfarm
|
$ 500
|
$ 500
|
|
|
Optional
nonfarm
|
|
|
$1,000
|
$1,000
|
| Amount you can report: |
$1,400 |
$1,300 |
$1,900 |
$1,600* |
|
*Limited to $1,600 because you used both optional methods.
|
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.
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