Publication 533
Self- Employment Tax

For use in preparing 2002 Returns

Important Change

Tax rates and maximum net earnings.   The self-employment tax rate on net earnings remains the same for 2002 and 2003. This rate, 15.3%, is a total of 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).

The maximum amount subject to the social security part for tax years beginning in 2002 is $84,900. For 2003, that amount increases to $87,000. All net earnings of at least $400 are subject to the Medicare part.

Important Reminder

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Introduction

The purpose of this publication is to help you understand self-employment tax. It explains:

• What is self-employment tax,
• Why you pay it,
• How you pay it,
• Who must pay it, and
• How to report it on your tax return.

How to use this publication.   This publication is designed to be used with Schedule SE (Form 1040) and its instructions. Schedule SE is used to figure and report self-employment tax. This publication may help you if you need more information than the form or instructions provide.

Comments and suggestions.   We welcome your comments about this publication and your suggestions for future editions.

You can e-mail us while visiting our web site at www.irs.gov.

You can write to us at the following address:

Internal Revenue Service
Tax Forms and Publications
W:CAR:MP:FP
1111 Constitution Ave. NW
Washington, DC 20224

We respond to many letters by telephone. Therefore, it would be helpful if you would include your daytime phone number, including the area code, in your correspondence.

Useful Items

You may want to see:

Publication

• 15   Circular E, Employer's Tax Guide
• 15-A   Employer's Supplemental Tax Guide
• 225   Farmer's Tax Guide
• 334   Tax Guide for Small Business
• 505   Tax Withholding and Estimated Tax
• 517   Social Security and Other Information for Members of the Clergy and Religious Workers
• 541   Partnerships
• 595   Tax Highlights for Commercial Fishermen
• 911   Direct Sellers

Form (and Instructions)

• 1040   U.S. Individual Income Tax Return
• Sch C (Form 1040)   Profit or Loss From Business
• Sch C-EZ (Form 1040)   Net Profit From Business
• Sch F (Form 1040)   Profit or Loss From Farming
• Sch K-1 (Form 1065)   Partner's Share of Income, Credits, Deductions, etc.
• Sch K-1 (Form 1065-B)   Partner's Share of Income (Loss) From an Electing Large Partnership
• Sch SE (Form 1040)   Self-Employment Tax
• 4029   Application for Exemption From Social Security and Medicare Taxes and Waiver of Benefits
• 4361   Application for Exemption From Self-Employment Tax for Use by Ministers, Members of Religious Orders and Christian Science Practitioners

See How To Get Tax Help near the end of this publication for information about getting publications and forms.

What Is Self-Employment Tax?

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 figure SE tax yourself using Schedule SE (Form 1040). Social security and Medicare taxes of most wage earners are figured by their employers. Also, you can deduct half of your SE tax in figuring your adjusted gross income. Wage earners cannot deduct social security and Medicare 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).

Maximum earnings subject to SE tax.   Only the first $84,900 of your combined wages, tips, and net earnings in 2002 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 your combined wages, tips, and net earnings in 2002 are subject to any combination of the 2.9% Medicare part of SE tax, social security tax, or railroad retirement (tier 1) tax.

Fiscal year filer.   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.

Self-employment tax deduction.   You can deduct half 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 29, the amount shown on the Deduction for one-half of self-employment tax line of the Schedule SE.

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.

By not reporting all your self-employment income, you could cause your social security benefits to be lower when you retire.

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). It does not matter whether the income is earned in one quarter or is spread over two or more quarters.

Earning credits in 2002 and 2003.   You can earn a maximum of four credits per year. For 2002, you earn one credit for each $870 ($890 for 2003) 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 2003, you will need $3,560 ($890 × 4) of self-employment income and wages to earn four credits.

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.

The 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.

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, Application for a Social Security Card. You can get this form at any Social Security office or by calling 1-800-772-1213.

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

If you have a social security number from the time you were an employee, you must use that SSN. 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 the 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.

How to avoid paying estimated tax.   If you are self-employed and you are also an employee, you may be able to avoid paying estimated tax by having your employer increase the income tax taken out of your pay. Use Form W-4, Employee's Withholding Allowance Certificate, to increase your withholding.

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.

More information.   For more information on estimated tax, see Publication 505.

Who Must Pay
Self-Employment Tax?

You must pay SE tax and file Schedule SE (Form 1040) if either of the following applies.

• Your net earnings from self-employment (excluding church employee income ) were $400 or more.
• You had church employee income of $108.28 or more. See Church employee, later.

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 Self-Employment 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 getting social security or Medicare benefits.

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.

However, you may qualify for an exemption from the SE tax if you are a member of a recognized religious group. See Member of Recognized Religious Group, later.

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.

1. 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:
   1. A foreign government,
   2. A wholly-owned instrumentality of a foreign government, or
   3. An international organization.
2. 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. (See Table 1.) 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.

More information.   For more information, contact the social security agency of the country in which you are living, visit the United States Social Security Administration (SSA) web site at www.ssa.gov/international, call the SSA Office of International Programs at (410) 965-3544 or (410) 965-0377, or write to:

Social Security Administration
Office of International Programs
P.O. Box 17741
Baltimore, MD 21235-7741

Are You Self-Employed?

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.
• You are otherwise in business for yourself.

Trade or business.   A trade or business is generally an activity carried on for a livelihood or in good faith to make a profit. The facts and circumstances of each case determine whether or not an activity is a trade or business. The regularity of activities and transactions and the production of income are important elements. You do not need to actually make a profit to be in a trade or business as long as you have a profit motive. You do need, however, to make ongoing efforts to further the interests of your business.

Part-time business.   You do not have to carry on regular full-time business activities to be self-employed. Having a part-time business in addition to your regular job or business also may be self-employment.

Example.   You are employed full time as an engineer at the local plant. You fix televisions and radios during the weekends. You have your own shop, equipment, and tools. You get your customers from advertising and word-of-mouth. You are self-employed as the owner of a part-time repair shop.

Sole proprietor.   You are a sole proprietor if you own an unincorporated business by yourself, in most cases. However, if you are the sole member of a domestic limited liability company (LLC), you are not a sole proprietor if you elect to treat the LLC as a corporation. For more information on this election and the tax treatment of a foreign LLC, see Form 8832, Entity Classification Election.

Independent contractor.   People such as doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers, or auctioneers who are in an independent trade, business, or profession in which they offer their services to the general public are generally independent contractors. However, whether these people are independent contractors or employees depends on the facts in each case. The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. The earnings of a person who is working as an independent contractor are subject to SE tax.

You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done). This applies even if you are given freedom of action. What matters is that the employer has the legal right to control the details of how the services are performed.

If an employer-employee relationship exists (regardless of what the relationship is called), you are not an independent contractor and your earnings are generally not subject to SE tax. However, your earnings as an employee may be subject to SE tax under other rules discussed in this section.

For more information on determining whether you are an independent contractor or an employee, see Publication 15-A.

Guidelines for Selected Occupations

This section provides information to help you determine whether your earnings from one of the following occupations are subject to SE tax.

• Retired or former insurance agent.
• Fishing crew member.
• Newspaper carrier or distributor.
• Newspaper or magazine vendor.
• Notary public.
• Public official.
• Real estate agent or direct seller.
• Dealer in securities.
• Executor or administrator.
• Minister, Christian Science practitioner, or member of religious order.
• Member of recognized religious group.
• Trader in securities.

Retired Insurance Agent

Income paid by an insurance company to a retired self-employed insurance agent based on a percentage of commissions received before retirement is subject to SE tax. Also, renewal commissions and deferred commissions for sales made before retirement are generally subject to SE tax.

However, renewal commissions paid to the survivor of an insurance agent are not subject to SE tax.

Former Insurance Agent

Termination payments you receive as a former self-employed insurance agent from an insurance company because of services you performed for that company are exempt from SE tax if all the following conditions are met.

• You received payments after your agreement to perform services for the company ended.
• You did not perform any services for the company after your service agreement ended and before the end of the year in which you received the payment.
• You entered into a covenant not to compete against the company for at least a 1-year period beginning on the date your service agreement ended.
• The amount of the payments depended primarily on policies sold by or credited to your account during the last year of your service agreement or the extent to which those policies remain in force for some period after your service agreement ended, or both.
• The amount of the payment did not depend to any extent on length of service or overall earnings from services performed for the company (regardless of whether eligibility for the payments depended on length of service).

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.

1. 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.
   1. The pay is not more than $100 per trip.
   2. The pay is received only if there is a minimum catch.
   3. The pay is solely for additional duties (such as those as mate, engineer, or cook) for which additional cash pay is traditional in the fishing industry.
2. You get a share of the catch or a share of the proceeds from the sale of the catch.
3. Your share depends on the amount of the catch.
4. 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.

For more information about commercial fishing, see Publication 595.

Newspaper Carrier or Distributor

You are a direct seller and your earnings are subject to SE tax if all the following conditions apply.

• You are in the business of delivering or distributing newspapers or shopping news (including directly related services such as soliciting customers and collecting receipts).
• Substantially all your pay for these services directly relates to your sales or other output rather than to the number of hours you work.
• You perform the services under a written contract that says you will not be treated as an employee for federal tax purposes.

This rule applies whether or not you hire others to help you make deliveries. It also applies whether you buy the papers from the publisher or are paid based on the number of papers you deliver.

For more information about direct sellers, see Publication 911.

Newspaper or Magazine Vendor

If you are 18 or older and you sell newspapers or magazines, your earnings are subject to SE tax if all the following conditions apply.

• You sell newspapers or magazines to ultimate consumers.
• You sell them at a fixed price.
• Your earnings are based on the difference between the sales price and your cost of goods sold.

This rule applies whether or not you are guaranteed a minimum amount of earnings. It also applies whether or not you receive credit for unsold newspapers or magazines you return to your supplier.

Notary Public

Fees you receive for services you perform as a notary public are not subject to SE tax.

Public Official

Public officials generally are not subject to SE tax on what they earn for serving in public office. This rule applies to payments received by an elected tax collector from state funds on the basis of a fixed percentage of the taxes collected. Public office includes any elective or appointive office of the United States or its possessions, the District of Columbia, a state or its political subdivisions, or a wholly owned instrumentality of any of these.

Exception.   Public officials of state or local governments are subject to SE tax on their fees if they are paid solely on a fee basis and if their services are eligible for, but not covered by, social security under a federal-state agreement.

Real Estate Agent or Direct Seller

If you are a licensed real estate agent or a direct seller, your earnings may be subject to SE tax if both the following apply.

• Substantially all your pay for services as a real estate agent or direct seller directly relates to your sales or other output rather than to the number of hours you work.
• You perform the services under a written contract that says you will not be treated as an employee for federal tax purposes.

For more information about direct sellers, see Publication 911.

Dealer in Securities

If you are a dealer in options or commodities, your gains and losses from dealing or trading in section 1256 contracts (regulated futures contracts, foreign currency contracts, nonequity options, dealer equity options, and dealer securities futures contracts) or property related to those contracts (such as stock used to hedge options) are subject to SE tax. For more information, see sections 1256 and 1402(i) of the Internal Revenue Code.

Executor or Administrator

If you administer a deceased person's estate, your fees are subject to SE tax if you are one of the following.

1. A professional fiduciary.
2. A nonprofessional fiduciary (personal representative) and both of the following conditions apply.
   1. The estate includes an active trade or business in which you actively participate.
   2. Your fees are related to the operation of that trade or business.
3. A nonprofessional fiduciary of a single estate that requires extensive managerial activities on your part for a long period of time, provided these activities are enough to be considered a trade or business.

Report fees that are subject to SE tax on Schedule C or C-EZ (Form 1040). If the fees are not subject to SE tax, report them on line 21 of Form 1040.

Minister, Christian Science Practitioner,
or Member of Religious Order

You generally are subject to SE tax on earnings for services you perform as a minister, Christian Science practitioner, or member of a religious order who has not taken a vow of poverty. But you can get an exemption from SE tax on certain earnings by filing Form 4361.

For more information, see Publication 517.

Member of religious order who has taken a vow of poverty.   If you belong to a religious order and took a vow of poverty, you are not subject to SE tax on your earnings for performing duties required by the order.

Member of Recognized
Religious Group

If you belong to a recognized religious group opposed to insurance, you may qualify for an exemption from the SE tax. To qualify, you must be conscientiously opposed to accepting the benefits of any public or private insurance that makes payments because of death, disability, old age, retirement, or medical care, or that provides services for medical care. If you buy a retirement annuity from an insurance company, you will not be eligible for this exemption. Religious opposition based on group teachings is the only legal basis for the exemption. In addition, your religious group (or division) must have existed since December 31, 1950.

To get the exemption, you must file in triplicate Form 4029 and waive all social security benefits.

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