Self-employment income is basically the net income you report on Schedule C, Profit or Loss From Business or Profession. If you are a member of a partnership that carries on a trade or business, your share of partnership income counts as self-employment income, too, and any losses reduce the income subject to the tax. But if you're an investor in a limited partnership, your share of income and losses doesn't come into play for purposes of the self-employment tax.
Nor does this tax apply to investment income, such as interest, dividends or capital gains, or to rental income (unless you are a real estate dealer or you provide hotel-like services in connection with the rental.)
Employees don't have to worry about the self-employment tax. Instead, they pay for Social Security via the FICA, Federal Insurance Contribution Act, tax. Half of that tax is withheld from their pay and the other half paid by their employer. When you are your own employer, however, you have to figure the tax and pay the full amount yourself.
See Self-Employment Tax Deduction for more information.
Here's a break: When figuring self-employment tax you owe, you get to reduce self-employment income by 7.65% before applying the tax rate. Say, for example, that your net self-employment income is $50,000. That's the amount you report as taxable for income tax purposes on Form 1040. But when figuring your self-employment tax on Schedule SE, Computation of Social Security Self-Employment Tax, the taxable amount is $46,175. Not paying the 15.3% tax on $3,825 difference in this example saves you $585.
(The savings evaporate at higher income levels. When 2006 self-employment income hit $94,200, for example, even after the 7.65% reduction, the 15.3% rate applies to the maximum $90,000 to which the full self-employment tax applies in 2006. Above that level, then, the reduction saves not the full 15.3% but only the 2.9% Medicare portion of the tax which applies to all self-employment income.)
TaxCut handles all of this automatically when preparing your Schedule SE.
Unlike the income tax, there is a limit on how much income is vulnerable to the self-employment tax. The amount rises each year, however, and to complicate things further, different parts of the self-employment tax apply to different amounts of income.
This tax really has two parts: 12.4% pays for the Social Security retirement benefits; the other 2.9% goes to pay for Medicare. Until 1991, the difference was rather academic to the taxpayer: Since both parts applied to the same amount of income, it was fine to think of it as a single tax, with a 15.3% rate.
Now, however, if your 2006 income (from self-employment or a combination of self-employment and a job as an employee) is over $94,200 you have to know there are two parts. Here's why: For 2006, the full 15.3% tax applies to the first $94,200 of self-employment income. At that point, the 12.4% Social Security part of the tax stops, but the 2.9% Medicare tax continues to apply to all self-employment income. (Each year, the amount to which the full tax load applies increases to keep up with increases in average wages nationwide.)
For purposes of these income caps, "income" includes net self-employment income and any wages earned on a job on which Social Security taxes are withheld. If you have a job as an employee and earned $50,000 in 2006 on which FICA was withheld, for example, the full, 15.3% self-employment tax would apply only to the first $44,200 (minus the 7.65% deduction explained above) of self-employment income. That amount, plus the $50,000 of wages, would bring you up to 2006's $94,200 cap.
There are optional methods for figuring the amount of self-employment tax due. But it's doubtful that you'll want to spend any time trying to see if an alternative technique can save you money. The options are available only to those with small amounts of self-employment income and are designed to permit individuals to pay extra self-employment tax. The point is that by doing so a taxpayer may be able to increase the income base used to set his or her Social Security benefits.
One final point about the self-employment tax. What you owe in self-employment tax must be taken into account when figuring quarterly estimated tax payments.
How would you like to send an extra 15.3% of your income to Uncle Sam—on top of what you pay in income taxes? That's what you could owe in Social Security and Medicare taxes if you earn self-employment income. It doesn't matter whether the earnings come from a full-time business, say, or occasional moonlighting. If that net income is $400 or more, say hello to the self-employment tax. It's officially known as the SECA, Self-employment Contribution Act, tax.
You can't just multiply the appropriate tax rate times your self-employment income. There's more to it than that, but at least the extra effort is likely to save you money.
First of all, you get to reduce self-employment income by 7.65% before applying the tax rate. Another rule further cuts the actual out-of-pocket cost of the self-employment tax by giving you an income tax deduction for 50% of the self-employment tax you pay.
TaxCut handles all the calculations for you, based on the self-employment income you report on Schedule C.
Self-employment income is basically the net income you report on Schedule C, Profit or Loss From Business or Profession. If you are a member of a partnership that carries on a trade or business, your share of partnership income counts as self-employment income, too, and any losses reduce the income subject to the tax. But if you're an investor in a limited partnership, your share of income and losses don't come into play for purposes of the self-employment tax.
This tax does not apply to investment income, such as interest, dividends or capital gains, or to rental income (unless you are a real estate dealer or you provide hotel-like services in connection with the rental.)
Employees don't have to worry about the self-employment tax. Instead, they pay for Social Security via the FICA, Federal Insurance Contribution Act, tax. Half of that tax is withheld from their pay and the other half paid by their employer. When you are your own employer, however, you have to figure the tax and pay the full amount yourself.