15. Self-Employment Tax
Important Change
for 2002
Tax rates and maximum net earnings. The maximum
net self-employment earnings subject to the social security part (12.4%) of the
self-employment tax increased to $84,900 for 2002. There is no maximum limit on
earnings subject to the Medicare part (2.9%).
Important Change
for 2003
Maximum net earnings. The maximum net self-employment earnings
subject to the social security part of the self-employment tax will be published in
Publications 533 and 553. There is no maximum limit on earnings subject to the Medicare
part.
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 tax,
as well. See chapter 16 for information on employment taxes.
SE tax rate. 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:
- Who must pay self-employment tax
- Figuring earnings subject to self-employment tax
- Landlord participation in farming
- Methods for figuring net earnings
- Reporting self-employment tax
Useful Items
You may want to see:
Publication
- 533 Self-Employment Tax
- 541 Partnerships
Form (and Instructions)
- SS-5 Application for a Social Security Card
- 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, Credits, Deductions, etc.
See chapter 21 for information about getting publications and forms.
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.
- You produce a crop or raise livestock on land belonging to another person.
- 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.
- Taxable patronage dividends (distributions) from cooperatives.
- 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.)
- Taxable Commodity Credit Corporation loans.
- Refunds and rebates, if they represent a reduction in a deductible expense item,
including a fuel tax credit included in income.
- Prizes or awards on farm produce or livestock.
- Crop damage payments.
- Value of property and services received for farm products.
- Sales of unharvested crops, if not sold with land that was held more
than 1 year.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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 one year.
- 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.
- 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.
- Wages paid in kind to you for agricultural labor, such as commodity wages, are not
included in earnings subject to SE tax.
- 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.
- 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.
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.
- You do any three of the following.
- Pay, using cash or credit, at least half the direct costs of producing the crop or
livestock.
- Furnish at least half the tools, equipment, and livestock used in the production
activities.
- Advise or consult with your tenant.
- Inspect the production activities periodically.
- You regularly and frequently make, or take an important part in making, management
decisions substantially contributing to or affecting the success of the enterprise.
- You work 100 hours or more spread over a period of 5 weeks or more in activities
connected with agricultural production.
- 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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