12.   Self-Employment Tax

What's New for 2013

Tax rates. For tax years beginning in 2013, the social security part of the self-employment tax increases from 10.4% to 12.4%. The Medicare part of the tax remains at 2.9%. As a result, the self-employment tax is increased from 13.3% to 15.3%.

Additional Medicare Tax. . For tax years beginning in 2013, a 0.9% Additional Medicare Tax applies to your Medicare wages, Railroad Retirement Tax Act (RRTA) compensation, and self-employment income above a threshold amount. Use Form 8959, Additional Medicare Tax, to figure this tax. For more information, see the Instructions for Form 8959.

Maximum net earnings. The maximum net self-employment earnings subject to the social security part (12.4%) of the self-employment tax increased to $113,700 for 2013. There is no maximum limit on earnings subject to the Medicare part (2.9%).

What's New for 2014

Maximum net earnings. The maximum net self-employment earnings subject to the social security part of the self-employment tax for 2014 will be discussed in the 2013 Publication 334.

Introduction

Self-employment tax (SE tax) is a social security and Medicare tax primarily for individuals who work for themselves. It is similar to the social security and Medicare taxes withheld from the pay of most wage earners.

You usually have to pay SE tax if you are self-employed. You are usually self-employed if you operate your own farm on land you either own or rent. You have to figure SE tax on Schedule SE (Form 1040).

Farmers who have employees may have to pay the employer's share of social security and Medicare taxes, as well. See chapter 13 for information on employment taxes.

Self-employment tax rate.   For tax years beginning in 2013, the self-employment tax rate is 15.3%. The rate consists of two parts: 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).

Topics - This chapter discusses:

  • Why pay self-employment tax

  • How to pay self-employment tax

  • Who must pay self-employment tax

  • Figuring self-employment earnings

  • Landlord participation in farming

  • Methods for figuring net earnings

  • Reporting self-employment tax

Useful Items - You may want to see:

Publication

  • 541 Partnerships

Form (and Instructions)

  • 1040 U.S. Individual Income Tax Return

  • Sch F (Form 1040) Profit or Loss From Farming

  • Sch SE (Form 1040) Self-Employment Tax

  • 1065 U.S. Return of Partnership Income

  • Sch K-1 (Form 1065) Partner's Share of Income, Deductions, Credits, etc.

See chapter 16 for information about getting publications and forms.

Why Pay Self-Employment Tax?

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

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 (also called quarters of coverage).

Earning credits in 2013.   You can earn a maximum of four credits per year. For 2013, you earn one credit for each $1,160 of combined wages and self-employment earnings subject to social security tax. You need $4,640 ($1,160 × 4) of combined wages and self-employment earnings subject to social security tax to earn four credits in 2013. It does not matter whether the income is earned in 1 quarter or is spread over 2 or more quarters.

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 or visit the SSA website at www.socialsecurity.gov.

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

The Social Security Administration (SSA) time limit for posting self-employment earnings.   Generally, the SSA will give you credit only for self-employment earnings 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 earnings after the SSA time limit for posting self-employment earnings, 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 earnings after the SSA time limit listed above.

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 an ITIN does not change your immigration or employment status under U.S. law.

Obtaining a social security number.   If you have never had an SSN, apply for one using Form SS-5, Application for a Social Security Card. The application is also available in Spanish. 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 website at  
www.socialsecurity.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, for tax use only, 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. You can get this form by calling 1-800-829-3676. For more information on ITINs, see Publication 1915, Understanding Your IRS Individual Taxpayer Identification Number. Form W-7 and Publication 1915 are also available in Spanish.

  
You can also download Form W-7 from the IRS website at IRS.gov.

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 SE 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 for 2013 or 2014 was from farming and you file your 2014 Form 1040 and pay all the tax due by March 2, 2015, you do not have to pay any estimated tax. For more information about estimated tax for farmers, see chapter 15.

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.

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.

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

Aliens.   Generally, resident aliens must pay self-employment tax under the same rules that apply to U.S. citizens. Nonresident aliens are not subject to self-employment tax. However, residents of the Virgin Islands, Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, or American Samoa are subject to self-employment tax, as they are considered U.S. residents for self-employment tax purposes. For more information on aliens, see Publication 519, U.S. Tax Guide for Aliens.

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, 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 net farm profit or loss from the income-sharing arrangement is reported on Schedule F (Form 1040) and included in your self-employment earnings.

  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 landowner has the right to direct or control your performance of services.

Example.

A share farmer produces a crop on land owned by another person on a 50-50 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 on a cropping plan.

The share farmer is a self-employed farmer for purposes of the agreement to produce the crops, and the share farmer's part of the profit or loss from the crops is reported on Schedule F (Form 1040) and included in self-employment earnings.

The tax treatment of the landowner is discussed later under Landlord Participation in Farming.

Contract farming.   Under typical contract farming arrangements, the grower receives a fixed payment per unit of crops or finished livestock delivered to the processor or packing company. Since the grower typically furnishes labor and bears some production risk, the payments are reported on Schedule F and are therefore subject to self-employment tax.

4-H Club or FFA project.   If an individual participates in a 4-H Club or Future Farmers of America (FFA) project, any net income received from sales or prizes related to the project may be subject to income tax. Report the net income as “Other 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.

Partners in a partnership.   Generally, you are self-employed if you are a member of a partnership that carries on a trade or business.

Limited partner.   If you are a limited partner, your partnership income is 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 in box 14 of your Schedule K-1 (Form 1065).

Business Owned and Operated by Spouses.   If you and your spouse jointly own and operate a farm as an unincorporated business and share in the profits and losses, you are partners in a partnership whether or not you have a formal partnership agreement. You must file Form 1065, instead of Schedule F, unless you make a joint election to be treated as a qualified joint venture. Making this election will allow you to avoid the complexity of Form 1065 but still give each spouse credit for social security earnings on which retirement benefits are based.

Qualified joint venture.   If you and your spouse each materially participate as the only members of a jointly owned and operated farm, and you file a joint tax return for the tax year, you can make a joint election to be treated as a qualified joint venture instead of a partnership for the tax year. For an explanation of “material participation,” see the instructions for Schedule C, line G, and the instructions for Schedule F, line E.

  To make this election, you must divide all items of income, gain, loss, deduction, and credit attributable to the business between you and your spouse in accordance with your respective interests in the venture. Each of you must file a separate Schedule F and a separate Schedule SE. For more information, see Qualified Joint Venture in the Instructions for Schedule SE (Form 1040).

Spouse employee.   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 about employment taxes, see chapter 13.

Community property.   If you are a partner and your distributive share of any income or loss from a trade or business carried on by the partnership is community property, treat your share as your self-employment earnings. Do not treat any of your share as self-employment earnings of your spouse.

Figuring Self-Employment Earnings

Farmer.   If you are self-employed as a farmer, use Schedule F (Form 1040) to figure your self-employment earnings.

Partnership income or loss.   If you are a member of a partnership that carries on a trade or business, the partnership should report your self-employment earnings in box 14, code A, of your Schedule K-1 (Form 1065). Box 14 of Schedule K-1 may also provide amounts for gross farming or fishing income (code B) and gross nonfarm income (code C). Use these amounts if you use the farm or nonfarm optional method to figure net earnings from self-employment (see Methods for Figuring Net Earnings , later).

  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, include only the deductible amount when you figure your total self-employment earnings.

  For more information, see the Partner's Instructions for Schedule K-1 (Form 1065).

  For general information on partnerships, see Publication 541.

More than one business.   If you have self-employment earnings from more than one trade, business, or profession, you generally must combine the net profit or loss from each to determine your total self-employment earnings. A loss from one business reduces your profit from another business. However, do not combine earnings from farm and nonfarm businesses if you are using one of the optional methods (discussed later) to figure net earnings.

Community property.   If any of the income from a farm or business, other than a partnership, is community property under state law, it is included in the self-employment earnings of the spouse carrying on the trade or business.

Lost income payments.   Lost income payments received from insurance or other sources for reducing or stopping farming activities are included in self-employment earnings. 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 self-employment earnings 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.

Gain or loss.   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 self-employment earnings. 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 self-employment earnings.
  • Investment property.

  • Depreciable property or other fixed assets used in your trade or business.

  • 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.

  • Unharvested standing crops sold with land held more than 1 year.

  • Timber, coal, or iron ore held for more than 1 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 self-employment earnings if the cutting is treated as a sale or exchange. For more information on electing to treat the cutting of timber as a sale or exchange, see Timber in chapter 8.

Wages and salaries.   Wages and salaries received for services performed as an employee and covered by social security or railroad retirement are not included in self-employment earnings.

  Wages paid in kind to you for agricultural labor, such as commodity wages, are not included in self-employment earnings.

Retired partner.   Retirement income received by a partner from his or her partnership under a written plan is not included in self-employment earnings if all the following apply.
  • The retired partner performs no services for the partnership during the year.

  • The retired partner is owed only the retirement payments.

  • The retired partner's share (if any) of the partnership capital was fully paid to the retired partner.

  • The payments to the retired partner are lifelong periodic payments.

Conservation Reserve Program (CRP) payments.   Under the Conservation Reserve Program (CRP), if you own or operate highly erodible or other specified cropland, you may enter into a longterm contract with the USDA, agreeing to convert to a less intensive use of that cropland. You must include the annual rental payments and any onetime incentive payment you receive under the program on Schedule F, lines 4a and 4b. Cost share payments you receive may qualify for the costsharing exclusion. See Cost-Sharing Exclusion (Improvements), above. CRP payments are reported to you on Form 1099G.

Individuals who are receiving Social Security retirement or disability benefits may exclude CRP payments when calculating self-employment tax. See the instructions for Schedule SE (Form 1040).

Self-employed health insurance deduction.   You cannot deduct the self-employed health insurance deduction you report on Form 1040, line 29, from self-employment earnings on Schedule SE (Form 1040).

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 self-employment earnings. 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 landowner 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 self-employment earnings 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 self-employment earnings includes the fair market value of the crop shares when they are used as feed.

Material participation for landlords.   You materially participate if you have an arrangement with your tenant for your participation and you meet one or more of the following tests.
  1. You do at least 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 advises Houston when to plant, 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 Clarke in connection with the care of the cotton crop and his regular inspection of the crop establish that he participates to a material degree in the cotton production operations. The income Clarke receives from his cotton farm is included in his self-employment earnings.

Methods for Figuring Net Earnings

There are three ways to figure your net earnings from self-employment.

  1. The regular method.

  2. The farm optional method.

  3. The nonfarm optional method.

You must use the regular method unless you are eligible to use one or both of the optional methods. See Figure 12-1 , shown later.

Figure 12-1. Can I Use the Optional Methods?

Figure 12-1. Can I Use the Optional Methods?
Please click here for the text description of the image.

Figure 12–1. Can I Use 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 may result in you getting higher social security disability or retirement benefits.

  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 SE tax or no SE 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 self-employment earnings in gross income, regardless of which method you use to determine SE tax.

Regular Method

Multiply your total self-employment earnings 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.

Farm Optional Method

Use the farm optional method only for self-employment earnings from a farming business. You can use this method if you meet either of the following tests.

  1. Your gross farm income is $6,960 or less.

  2. Your net farm profits are less than $5,024.

Gross farm income.   Your gross farm income is the total of the amounts from:
  • Schedule F (Form 1040), line 9, and

  • Schedule K-1 (Form 1065), box 14, code B (from farm partnerships).

Net farm profits.   Net farm profits generally are the total of the amounts from:
  • Schedule F (Form 1040), line 34, and

  • Schedule K-1 (Form 1065), box 14, code A (from farm partnerships).

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. For more information, see Partnership income or loss , earlier.

Figuring farm net earnings.   If you meet either of the two tests explained above, use Table 12-1. Figuring Farm Net Earnings , to figure your net earnings from self-employment under the farm optional method.

Table 12-1.Figuring Farm Net Earnings

IF your gross farm income 
is...
THEN your net earnings are equal to...
$6,960 or less Two-thirds of your gross farm income.
More than $6,960 $4,640

Optional method can reduce or eliminate SE tax.   If your gross farm income is $6,960 or less and your farm net earnings figured under the farm optional method are less than your actual net earnings, you can use the farm optional method to reduce or eliminate your SE tax. Your actual net earnings are your net earnings figured using the regular method, explained earlier.

Example.

Your gross farm income is $540 and your net farm profit is $460. Consequently, your net earnings figured under the farm optional method are $360 (2/3 of $540) and your actual net earnings are $425 (92.35% of $460). You owe no SE tax if you use the optional method because your net earnings under the farm optional method are less than $400.

Nonfarm Optional Method

This is an optional method available for determining net earnings from nonfarm self-employment, much like the farm optional method.

If you are also engaged in a nonfarm business, you may be able to use this method to figure your nonfarm net earnings. You can use this method even if you do not use the farm optional method for determining your farm net earnings and even if you have a net loss from your nonfarm business. For more information about the nonfarm optional method, see Publication 334.

You cannot combine farm and nonfarm self-employment earnings to figure your net earnings under either of the optional methods.

Using Both Optional Methods

If you use both optional methods, you must 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 $4,640 as your combined net earnings from self-employment.

Reporting Self-Employment Tax

Use Schedule SE (Form 1040) to figure and report your SE tax. Then, enter the SE tax on line 56 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. Use the chart on page 1 of Schedule SE to find out which one to use.

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.

Deduction for employer-equivalent portion of self-employment tax.   You can deduct the employer-equivalent portion of your SE tax in figuring your adjusted gross income. This deduction only affects your income tax. It does not affect either your net earnings from self-employment or your SE tax.

  To deduct the tax, enter on Form 1040, line 27, the amount shown on Section A, Line 6, or Section B, line 13, Deduction for employer-equivalent portion of self-employment tax, of the Schedule SE.

Joint return.   Even if you file a joint return, you cannot file a joint Schedule SE. This is true whether one spouse or both spouses have self-employment earnings. Your spouse is not considered self-employed just because you are. If both of you have self-employment earnings, 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. If you and your spouse operate a business as a partnership, see Business Owned and Operated by Spouses and Qualified joint venture , earlier, under Who Must Pay Self-Employment Tax .


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