Do you have to pay self-employment tax?
You pay self-employment tax when your net earnings from self-employment total $400 or more. Self-employment generally includes any business that you conduct as a
- Sole proprietor (including farming),
- General partner in a partnership,
- Trade or business that you engage in to make a profit.
Self-employment does not have to be your primary source of income: if you have a day job and have a small business on the side, you may still be liable for self-employment taxes.
The logic of self-employment taxes is this: when a company employs you, the company pays a portion of your payroll taxes, and you pay a portion. When you are self-employed, you have to pay both your portion and the company portion.
Below we go through more detail about what self-employment taxes are, how to pay them, and some specific situations and their implications on self-employment tax.
Self-employment tax defined
Two taxes make up self-employment tax: Social Security and Medicare.
When you work for a company, your employer pays half of the tax and deducts the other half from your pay. Since as a self-employed individual you are both the company and the employee, you are responsible for both halves of these taxes.
The Social Security Portion
Social security is the most significant part of the self-employment tax. The total Social Security tax is 12.4% of your income on the first $142,800 (in 2021) of your income. This maximum income amount increases every year, so verify the amount.
As an employee, you would pay 6.2% of your income; as a self-employed individual, you pay the full 12.4%.
The Medicare Portion
The Medicare tax is 2.9% of your income, and there is no maximum. There is, however, an additional Medicare tax of 0.9% on Self-employed income over $200,000 (or $250,000 married filing jointly).
The Self-Employment tax deduction
You are allowed to deduct half of the self-employment tax, which reduces the liability somewhat. Because of this deduction, 92.35% of your self-employment income is subject to tax.
Then you can deduct one-half of your self-employment tax from your federal income taxes (see the example below). This feels circular but works out as you will see.
Paying Self-Employment tax
This is where keeping good books and recording your expenses and income clearly throughout the year come into play.
The Self-Employment Contributions Act of 1954 requires every taxpayer to claim all allowable business deductions, including depreciation, in computing net earnings from self-employment. It also provides penalties for making false statements. So careful record-keeping can be beneficial in making sure you pay the correct tax.
Here is an example that will hopefully clarify the situation
Donna runs a business that has $250,000 in revenue and $150,000 in legitimate business expenses. Her self-employment tax looks like this:
- Start with revenue: $250,000
- Subtract expenses: $150,000
- To get self-employment Income: $100,000
- 92.35% of line three is subject to self-employment tax, so: $92,350 (you see why I used round numbers).
- Self-employment tax (multiple line 4 by 15.3%) is therefore: $14,130
- Deduction for one-half of self-employment tax (line 5 times 50%): $7,065 (so much for round numbers).
When Donna computes her tax, she will deduct $7,065 from her federal income and pay $14,130 in addition to her federal income tax.
Common self-employment tax situations
As with all tax situations, there are exceptions and specific rules that may affect your situation. Below are a few of these, but to give you specific advice we would have to review your specific situation.
Hobby Income is not subject to self-employment tax
This is income from activities you do without an expectation of profit; it is a recreational pursuit. An example might be if you are good with cars and your neighbor pays you to change the oil. Another example might be selling a few home-brewed beers to a friend.
Once these activities start contributing to your income, they become a business and are subject to self-employment tax.
Partner income is subject to self-employment tax
Both guaranteed payments and general partners’ distributions are subject to self-employment tax.
Department of Agriculture payments are subject to self-employment tax unless they are non-farmer payments
The Department of Agriculture’s land diversion program makes payments to farmers and non-farmers. In the case of farmers, the payments are considered income and subject to self-employment tax. In the case of non-farmers, the payments are considered rental income and are not subject to self-employment tax.
Rental real-estate is not subject to self-employment tax
Rentals are not subject to self-employment tax, but services are. So if you provide substantial services, such as in a hotel or a camp, the income would be subject to self-employment tax.
Community property states – spouses don’t earn half
State laws that say income is earned one-half by each spouse do not apply for federal self-employment tax. The spouse who makes the income owes the tax.
Notary Public income is not subject to self-employment tax
Any income derived from services as a notary public is exempt from self-employment tax.
Corporate director fees are subject to self-employment tax
Fees paid to corporate directors that are not employment income are subject to self-employment tax.
Church employees may have to pay self-employment tax
Churches can file a certificate exempting them from paying the employer portion of social security and Medicare taxes. If you work for a church and the church has such a certificate in effect, then you will have to pay self-employment tax
Ministers and members of a religious order pay self-employment tax or apply for an exemption
Self-employment tax is due on salaries and other income for religious services. Housing allowance income may be subject to self-employment tax. However, members of recognized religious groups can apply for an exemption. Also, members of a religious order who have taken a vow of poverty are exempt from self-employment tax.
Kids in business are not subject to self-employment tax if the work is not a primary occupation
A child under 18 delivering newspapers to customers is exempt from self-employment tax, as is a child under 21 who performs domestic services for his or her parent. Additionally, a child under age 18 who performs domestic services in a private home of an employer is exempt from self-employment tax if the services are not the child’s principal occupation.
These cover most situations, but if you have any questions about your specific situation, be sure to ask us.
What if your actions are a hobby?
The advantage of a hobby is that you don’t need to pay self-employment tax. So if what you do is genuinely a hobby, this classification will help you. You just report your hobby income as “other income” on your 1040 form.
Gross hobby income equals gross receipts minus the cost of goods sold.
In the past, taxpayers could deduct certain allowable “ordinary and necessary” hobby-related expenses. This itemized deduction applied up to the amount of earned income.
However, the Tax Cuts and Jobs Act eliminated all miscellaneous itemized deductions. That means that hobbyists now cannot deduct any expenses but still need to report and pay taxes on hobby-related income.
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