Determining Your Self-Employment Tax Liability
The Self-Employment Contributions Act (SECA) tax is the business owner's version of the FICA tax paid by employees and employers. The same contribution rates and income ceilings apply that apply to FICA tax.
New business owners are sometimes surprised to find out that in addition to their federal income taxes, they must also pay a significant percentage of their income to the government in the form of Self-employment Contributions Act (SECA) taxes.
The Self-Employment Contributions Act (SECA) tax is the business owner's version of the FICA tax that employers and employees pay. The basic tax rate for the self-employed under SECA is equal to both the employer's and employee's portion of the FICA tax.
Limitations Apply to SECA Tax Amount
The SECA tax, like the FICA tax, is actually three taxes bundled together: Medicare (Hospital Insurance or HI), the Additional Medicare surtax, and Social Security (Old Age, Survivors and Disability Insurance or OASDI).
Medicare portion. The Medicare portion (HI) of the SECA tax is 2.9 percent. (This rate combines the 1.45 employer-share and 1.45 employee-share imposed under FICA.) This tax is imposed on all your net business income, regardless of the amount earned during the year.
Additional Medicare surtax. This 0.9 percent surtax is imposed starting in 2013 (as a result of the Affordable Care Act) on earning in excess of $200,000 for unmarried taxpayers, $250,000 combined earnings of married taxpayers, filing jointly, and $125,000 for married taxpayers who file a separate return.
Social Security portion. The Social Security (OASDI) portion of the tax is 12.4 percent (6.2 for both the employee and employer-share). Unlike the HI tax and the Medicare surtax, the amount subject to tax is capped. For 2013, the OASDI portion of the tax is capped when your earning reach $113,700. For 2014, the OASDI tax applies to net earnings from self-employment up to the OASDI wage base of $117,000.
For the HI and OASDI purposes, including determining whether you meet the income ceiling, only your own earnings, and not those of your spouse, are counted. This is not the case for the new 0.9 percent Medicare surtax, discussed below.
Medicare Surtax Hits Higher Earning Taxpayers Starting in 2013
As noted earlier, beginning in 2013, a new employment tax enters the picture for higher earning taxpayers: a 0.9 percent Medicare surtax. This additional 0.9 percent Medicare tax is imposed on wages, compensation and self-employment earnings above a threshold amount, starting January 1, 2013.
Once the threshold is reached, the tax applies to all wages that are currently subject to Medicare Tax, to the Railroad Retirement Tax Act or to the Self-Employment Compensation Act. This 0.9 percent tax is imposed solely on the employee— self-employed individuals are liable for the 0.9 percent, but as with employees, there is no need to "match" an employer-share.
The threshold amounts are as follows:
|Filing Status ||Threshold Amount |
|Married filing jointly - COMBINED INCOME ||$250,000 |
|Married filing separately ||$125,000 |
|Single, Head of Household, Qualifying Widow(er) ||$200,000 |
Note that this tax is imposed on the combined earnings of a married couple--providing a type of marriage penalty similar to that created by the 3.8 percent net investment income tax. Also, note that these amounts are not indexed for inflation--creating the type of "rate creep" that plagued the AMT for many years.
You use Form 8959, Additional Medicare Tax, to figure this tax. See our article, "Computing the Additional Medicare Tax" for additional information, including the computations rules and examples for self-employed individuals.
What Income Is Subject to SECA Tax?
For starters, you don't have to worry about paying the SECA tax at all if your total business income from all Schedule Cs combined and from any partnership or S corporation income that is treated as self-employment income, is less than $400.
But if your total self-employment income is $400 or more, you must file a Schedule SE and pay SECA tax on your entire net business income, including the first $400.
Since it's the net income from your business that is the basis of SECA tax, certain types of income are not included: interest and dividends, sales of business property or other assets, and rental income from real estate or personal property. However, rental income does count if generating rental income is your core business; for instance, if you are a real estate developer in the business of renting or selling property, you operate a bank, or you are in the rent-to-own business. Any income from your hobbies is not subject to SECA tax.
Income reported on joint returns. If you are filing jointly and your spouse also files one or more Schedule Cs, each spouse must count his or her own income separately.
You own two small businesses and file two Schedule Cs.Business A had net income of $80,000 and Business B had a net loss of $5,000.
Your spouse also operated a business as a sole proprietor, and had net income of $20,000. On Line 12 of your Form 1040, you would report all schedule C income earned by both you and your spouse: $80,000 + $20,000 - $5,000 = $95,000.
However, for SECA tax purposes, your total net business income would be $80,000 - $5,000 = $75,000. Your spouse's total net income for SECA purposes would be $20,000. You must each file one Schedule SE and attach both of them to your joint Form 1040.
Medicare surtax. Suppose the three businesses do very well in 2013. Business A has a net income of $125,000 and business B has a net income of $50,000, for a total of $175,000. Your spouse's business also did well and has a net income of $100,000.
You and your spouse will be subject to the new Medicare surtax on earnings because your earnings are combined to determine whether the Medicare surtax floor is met. In this case, your combined $275,000 income exceeds the $250,000 married, filing jointly threshold by $25,000. Thus, you will have to pay a 0.9 percent tax on that $25,000 in addition to all the other taxes that you will owe.
You May Be Eligible for Credit for FICA Tax Withheld
If you have earnings from a regular job, or perhaps more than one job, your employer will automatically be withholding FICA tax on your wages. Your wages, salary, bonus, tips, etc. earned on the job will count toward the ceiling amount, and at most your SECA tax will apply to the difference.
Overpayments of FICA tax. If you had more than one job during the year and the total of all your income from those jobs added up to more than $113,700 in 2013 ($117,000 in 2014), you don't need to pay any SECA tax on your self-employment income. What's more, it's likely that too much Social Security tax has been withheld from your paychecks.
Take a look at the amount in Box 4 on all of your W-2 Forms. If you add them up and the sum is more than $7,049 ($113,700 x 6.2 percent) in 2013, you've paid too much tax. The overpayment (what you've paid, minus the maximum dollar amount) can be claimed as a subtraction from your tax bill on Line 67 of Form 1040. You cannot use Form 1040EZ or Form 1040A to claim this overpayment.
Special rules apply in certain cases. Some special rules apply to the following types of income and taxpayers:
- partnership distributions;
- corporate payments;
- religious exemption income;
- aliens' income; and
- miscellaneous income.
Computing Your SECA Tax
Schedule SE is used to compute self-employment tax (SECA.) Schedule SE comes in two versions: the long form or the short form.
Computing of SECA Using the Regular Method
You compute your SECA tax using Schedule SE, which comes in two flavors: the long version or the short version. Most people can use the short version of the form. Those who cannot use the short version include
- those whose total wages, tips, salary and earnings from self employment were more than $113,700 in 2013 ($117,000 in 2014)
- religious workers who owe self-employment taxes or
- farmers or low-income people who elect to compute their SECA tax using one of the optional methods discussed below.
Computing SECA Tax Using the Regular Method
Unless you are using one of the optional methods, your self-employment tax is computed using the following steps.
- Transfer your net self-employment income from all Schedule Cs (and/or Forms K-1) to Lines 1 and 2 of either the short SE form or the long SE.
- Multiply your total net self-employment income by 92.35 percent to get your taxable net earnings from self employment. This has the effect of giving you a deduction from your income to reflect the fact that employees don't have to pay FICA tax on the portion of FICA that their employers pay them.
- Multiply the first $113,700 for 2013 ($117,000 in 2014) of the result in Step 2 by 15.3 percent to arrive at your SECA tax.
- Multiply the amount over $113,700 ($117,000 in 2014) by 2.45 percent.
- Add these amount together to arrive at your SECA tax for the year.
- Enter the amount of your SECA tax on Line 5 of the short SE or Line 12 of the long SE, and then transfer it to Line 58 of your Form 1040 and add it to the income tax you owe.
- Don't forget the very last step, which is to give yourself an income tax deduction for one-half of your SECA tax (computed on Line 6 of the short SE and Line 13 of the long one). This amount is transferred to Line 27 of your Form 1040.
This multiple-step computation has the effect of allowing you to avoid paying income tax on one-half of your SECA tax amount, just as employees do not have to pay income tax on the amount of FICA tax that their employers pay for them.
Optional Computations Aid Those With Insufficient Social Security Quarters
Optional methods for computing SECA taxes exist because your ability to collect Social Security disability and retirement benefits depends on your having worked and paid Social Security taxes for a certain length of time during your lifetime.
Generally you need to have worked for at least 40 calendar quarters (or 10 years) in which you were covered by Social Security and earned a minimum amount. For 2013, you must earn $1,160 to get a quarter of coverage ($1,200 for 2014). So, if you earn $4,640 or more in 2013 ($4,800 in 2014), you will be credited with four quarters.
As a result, people who were relatively close to retirement when they began working, or who had been out of the workforce or had worked for many years at very low-paying jobs can be in danger of not qualifying for retirement benefits. In particular, some farmers whose income fluctuates a great deal from year to year and who often suffer an annual financial loss may need some help in gaining more quarters of coverage.
Hence, the optional methods of computing net earnings from self-employment, which operate by allowing you to pay SECA tax as if your net earnings were higher than they actually were.
There is a special optional method for farmers, and a slightly less lenient method for low-income non-farmers. Either of these methods can also help you if you are entitled to the Earned Income Credit (EIC) because increasing your net self-employment income will help you to obtain a higher EIC amount.
If you think you may want to use either of the optional methods, see the instructions to Schedule SE for more information. Part II of the long version of Schedule SE will walk you through the computations.
Farm Optional Method. The farm optional method can be used an unlimited number of times. This method is available in 2013 only if:
- your gross farm income did not exceed $6,980 (from Form 1040 Schedule F (Line 11)or from Form 1065 Schedule K-1 (box 14, code B)) or
- your net farm profits were less than $5,024 (from Form 1040 Schedule F (Line 36) or from Form 1065 Schedule K-1 (box 14, code A)).
Nonfarm optional method. This method can not be used more than five times. In 2013, you can use this method only if your non-farm profits were less than $5,024 and also
less than 72.189 percent of your gross non-farm income.
Special Circumstances Can Affect SECA Liability
Partners, corporate shareholders, religious workers and aliens all face special self-employment tax considerations. In addition, various types of income may be included in self-employment tax, even if it is not earned in your trade or business.
Partners and partnership income. Partners must include their distributions from the partnership as well as any guaranteed payments they receive for their services for the partnership as net self-employment income, on which SECA tax must be paid.
These amounts should be shown on the Schedule K-1 information return that you receive from the partnership at the end of the year. For all general partners, this is true whether you are an active or inactive member of the partnership. For limited partners, you need only to include any guaranteed payments, such as salary or professional fees received during the year.
There is an exception to this rule if the partnership is an investment club, and the club limits its activities to investing in CDs and securities, and collecting income on the investments. In that case the income is not considered self-employment income.
If you are a retired partner, you do not need to include your retirement income received from the partnership in net earnings from self-employment if all of the following are true:
- You are receiving periodic payments for life.
- Your share of the partnership capital has been fully repaid. The partnership owes you nothing but the retirement payments.
- You performed no services for the partnership this year.
S Corporation shareholders. If you are an S-corporation shareholder, unlike a partner, your distributions from the organization generally do not count as self-employment income and are not subject to SECA tax.
Shareholder-employees. If you are a shareholder and also an officer of the company who performs substantial services, you are considered an employee. Some reasonable amount of compensation for your services must be considered salary or wages, on which regular payroll taxes, including social security, Medicare, and income tax withholding, must be paid. Your salary or wages is not considered self-employment income.
Corporate directors. Corporate directors of either C or S corporations who receive fees are not considered employees. Instead, their fees are considered self-employment income. Again, if you are a corporate officer or other employee of either a C or S corporation, your income is subject to regular payroll taxes (including FICA) and you aren't considered self-employed for purposes of SECA tax.
Miscellaneous Income May Be Subject to SECA Tax
If you are the executor or administrator of a deceased person's estate, your fees are exempt from Self-Employment Contributions Act (SECA) tax and are simply reported as miscellaneous income on Line 21 of your Form 1040.
An exception to this rule applies if you are a professional fiduciary, or the estate includes an active trade or business that you participate in and your fees are related to operating the business, or your administrative duties are so extensive over a long period of time that they should be considered a trade or business. In any of these cases, you'd need to file a Schedule C to report the income and, in turn, a Schedule SE to report self-employment income.
Since statutory employees already have FICA tax withheld from their payments, they do not have to pay SECA tax.
Fees received as a notary public are not subject to SECA tax.
SECA Tax on Aliens Depends Upon Residency Status
Aliens who are residents of the United States are generally subject to the same tax rules as U.S. citizens, including Self-Employment Contributions Act (SECA) tax rules. Residents of the Virgin Islands, Puerto Rico, Guam, or American Samoa are also subject to SECA tax. Self-employment activities of U.S. citizens in these regions plus the Northern Mariana Islands are subject to SECA tax.
Nonresident aliens must pay SECA tax on income earned in the U.S. unless they are a citizen of a country that has a social security agreement or treaty in effect with the U.S. If an agreement is in effect, the terms of the agreement will dictate the rules.
Currently there are agreements in effect with Australia, Austria, Belgium, Canada, Chile, Czech Republic, Den-mark, Finland, France, Germany, Greece, Ireland, Italy, Japan, Luxembourg, the Netherlands, Norway, Poland, Portugal, South Korea, Spain, Sweden, Switzerland, and the United Kingdom. For more information, contact the social security agency of the relevant country, or the Social Security Administration.
Certain Religious Workers Are Exempt from SECA Tax
There are some special exemptions from SECA tax that may apply if you are a member of certain religions, or you work for a religious group.
Vows of poverty and ministerial exceptions. If you are a member of a religious order who has taken a vow of poverty, you are exempt from self-employment tax as long as you are working for the church or a church agency. But if you are working for yourself, you must pay SECA tax.
If you have not taken a vow of poverty, but you are a minister, member of a religious order, or a Christian Science practitioner, you can get an exemption from SECA tax if you file IRS Form 4361, Application for Exemption from Self-Employment Tax for Use by Ministers, Members of Religious Orders, and Christian Science Practitioners. To get a copy, call the IRS at 1-800-TAX-FORM or go to www.IRS.gov.
Conscientious objection to taxes. If you are a member of a recognized sect that has been in existence since December 31, 1950 and that is opposed to insurance, you may be exempt from social security and Medicare tax (and thus, SECA tax) if you are conscientiously opposed to pension plans or life, disability, or medical insurance and you waive all social security benefits.
To get the exemption, you must file IRS Form 4029, Application for Exemption from Social Security and Medicare Taxes and Waiver of Benefits, which you can obtain by calling 1-800-TAX-FORM or going to www.irs.gov.
Organizations electing exemptions. If none of the above apply to you and you are an employee of a church or church-controlled organization that has itself elected exemption from social security and Medicare taxes, you will have to pay SECA tax if you are paid $108.28 or more in a year by the church or organization.
Business Entity Compliance from CT Corporation — Partner with the Industry Leader
Contact your CT service representative now!