Self-Employment Tax
Self-employed individuals pay self-employment taxes instead of FICA taxes. Since these individuals have no employers, the entire tax is paid by the self-employed individuals. Like the FICA taxes to which employees and their employers are subject, the self-employment tax consists of two parts, Social Security old age, survivors, and disability insurance (OASDI) and Medicare (hospital insurance). For 2008, the Social Security (OASDI) tax rate is 12.4% and the Medicare tax rate is 2.9%. The maximum base amount of earnings subject to the Social Security portion of the FICA tax is $102,000 in 2008. All earnings are subject to the Medicare portion of the FICA tax.
If an individual, subject to self-employment taxes, also receives wages subject to FICA taxes during a tax year, the individual’s maximum base amount for self-employment taxes is reduced by the amount of wages as both employee and employer have already paid FICA taxes on the wages. Therefore, the total amount of earnings subject to both FICA and self-employment tax for 2008 cannot exceed $102,000 for the Social Security portion of the tax. Unless the total of wages and self-employment income exceeds the maximum subject to tax, there is no impact on the amount of tax calculated. If net earnings from self-employment are less than $400, no self-employment tax is payable.
The self-employment tax is imposed on net earnings from self-employment. Individuals with net earnings from self-employment of $400 or more are subject to self-employment tax. Net earnings from self-employment include gross income from a trade or business less trade or business deductions, the distributive share of partnership income from a trade or business, and income earned as an independent contractor.
Gains and losses from property transactions, except inventory transactions, and other unearned income are not considered self-employment income. In arriving at net earnings from self-employment only for purposes of computing the self-employment tax, self-employed taxpayers are allowed a deduction for AGI of one-half of the otherwise applicable self-employment tax. This deduction is determined by multiplying the net earnings from self-employment, before considering this deduction, by one-half of the sum of the self-employment tax rates applicable for the tax year. In addition, once the self-employment tax liability has been determined, the taxpayer is allowed a deduction for income tax purposes equal to one-half of the actual self-employment tax liability.
Example
Phyllis is a self-employed consultant in 2008. She earned $88,000 from her practice. Phyllis’s self-employment tax is calculated as follows:
Step 1: net earnings multiplied by 92.35% = $88,000 × .9235 = $81,268
Step 2: $81,268 × 15.3% = $12,434.00, the amount of self employment tax
Phyllis would have an adjustment to income on page 1 of Form 1040 of $6,217 = 50% × $12,434
Example
Assume in the previous example that Phyllis earned $117,000 from her practice. Phyllis’s self-employment tax is calculated as follows:
Step 1: net earnings multiplied by 92.35% = $117,000 × .9235 = $108,049.50
Step 2a: $108,049.50 × 2.9% = $3,133.44, the amount of Medicare tax
Step 2b: Add $12,648 (maximum income of $102,000 subject to Social Security tax × 12.4%), results in: $12,648 + 3,133.44 = $15,781
Phyllis would have an adjustment to income on page 1 of Form 1040 of $7,891 = 50% × $15,781
Example
Assume from the first example that Phyllis earned $88,000 from her practice, but was also an employee during that year and earned a salary of $21,000 that was subject to FICA taxes. Phyllis’s self-employment tax is calculated as follows:
Step 1a: net earnings multiplied by 92.35% = $88,000 × .9235 = $81,268
Step 1b: Subtract employee earnings from maximum = $102,000 − 21,000 = $81,000 = self-employed earnings subject to self-employment tax (if this amount had been greater than the amount in Step 1a, then that amount would be used to compute the tax)
Step 2a: $81,000 × 12.4% = $10,044, the amount of Social Security tax.
Step 2b: Add $2,357 ($81,268 × 2.9%) for Medicare. Total self-employment tax is $12,401
Phyllis would have an adjustment to income on page 1 of Form 1040 of $6,201 = 50% × $12,401
Self-employment tax is computed and reported on Schedule SE, Form 1040. A taxpayer who has both self-employed income and income from wages or salaries and subject to FICA tax must use section B—Long Schedule SE. Most other taxpayers can use section A—Short Schedule SE.
Questions and Problems
The self-employment tax applies to which of the following types of income?
Income from a trade or business.
The distributive share of partnership income.
Income earned as an independent contractor.
Income earned by taxpayer from cleaning services provided to tenants of taxpayers rental property.
All of the above
The self-employment tax is computed using:
Self-employed income with no limits
All self-employed income for Social Security, but the first $102,000 of income is used for the Medicare tax computation
All self-employed income for Medicare, but the first $102,000 of income is used for the Social Security tax computation
Only the first $102,000 of self-employed income is used in the computation for both Medicare and Social Security
Some other amounts are used in the computations
Dan has Schedule C net profit before self-employment tax of $106,500.
How much is Dan’s self-employment tax? $_________
How much is Dan’s adjustment for AGI for self-employment tax? $________
