Self-Employment Taxes

If you work for yourself, you are usually required to pay a self-employment tax, which is a combination of Social Security and Medicare taxes. It is very much like the Social Security and Medicare taxes withheld from the wages of most employees

You are self-employed if any of the following apply to you: you carry on a trade or business as a sole proprietor or an independent contractor; you are a member of a partnership that carries on a trade or business; or you are otherwise in business for yourself.

Taxpayers who work for themselves are entitled to Social Security benefits along with those who earn a wage. Payments of self-employment taxes contribute to coverage of the taxpayer who works for himself so that he will be entitled to retirement, disability, survivor, and hospital insurance benefits.

You must pay self-employment taxes if your net earnings from self-employment were $400 or more or you had church employee income of $108.28 or more. You are subject to self-employment 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.

If you have earnings subject to self-employment 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 self-employment tax. A loss from one business reduces your profit from another business and, therefore, reduces your liability for self-employment tax.

Do not include in earnings subject to self-employment 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.

There are three approved methods of calculating net earnings. You must use the regular method unless you meet the statutory criteria for either the nonfarm option or the farm optional method. Using an optional method could increase your self-employment tax. However, paying more tax can result in your getting higher benefits when you retire.

Although all self-employment earnings are subject to the Medicare portion of the self-employment tax, Congress has set a limit on the amount of earnings subject to the Social Security part of the tax.

As a self-employed individual, you may be required to make estimated tax payments if you do not have income tax withheld. A failure to make the necessary estimated payments could result in the imposition of penalties and interest.

Copyright 2010 LexisNexis, a division of Reed Elsevier Inc.