Understanding Self-Employment Income and Self-Employment Taxes
For many individuals, understanding the financial obligations that come with being self-employed is crucial. Specifically, self-employed individuals must be aware of the types of income considered self-employment income and the associated self-employment taxes. In the tax code, the Internal Revenue Code (IRC) under Section 1401 et. seq. provides the necessary guidelines for determining self-employment income subject to self-employment taxes.
What is Self-Employment Income?
Self-employment income generally refers to income generated from providing personal services for compensation or earning income from a trade or business. However, several types of income are excluded from this classification and are therefore not subject to self-employment taxes. These exclusions include stock trading (with exceptions), dividends, interest income, and rent derived from personal property.
Income Subject to Self-Employment Taxes
According to 26 USC 1401 et. seq., income from a 1099 form, as well as income from being a general partner in a partnership with ordinary income or a manager in an LLC with ordinary income, is considered self-employment income. This means that individuals who fall under these categories are required to pay self-employment taxes.
Key Exclusions
Stock Trading: While stock trading is generally considered self-employment income, there are specific exceptions for traders. Dividends: Dividends are not subject to self-employment taxes. Interest Income: Interest income does not constitute self-employment income. Rents: Income from rents, except for those who rent out personal property, is not considered self-employed income. Royalties: Royalties are not subject to self-employment taxes.When is Income Considered Self-Employment Income?
Income from pretty much every source is considered self-employed income, except for a few specific types as mentioned above. If you are being paid to work but are not receiving a W-2 form from your employer, you are subject to self-employment taxes. This is because you are considered self-employed and your employer is not withholding taxes for you.
Types of Self-Employment Income
Rendering of Personal Services: Income generated from providing personal services for compensation. Income from a Trade or Business: Income earned from operating a trade or business.Safe Assumptions and Filing Adjustments
It is often safer to assume that any income from which a W-2 has not been issued is subject to self-employment taxes. This means that self-employment income must be reported and taxes paid. If, after the tax year, it turns out that the income was not self-employment income, an individual can file an amended return and receive the overpayment back. However, if it turns out that your employer failed to follow the tax law and did not withhold taxes, you can still pay the appropriate taxes to avoid penalties.
Understanding FICA Taxes
The Federal Insurance Contribution Act (FICA) taxes include social security and Medicare taxes. For self-employed individuals, you are responsible for both the employer and employee portions of FICA taxes. This can be a significant responsibility, as for a single taxpayer earning $140,000, the total FICA tax can be about $11,140, split between the employer and employee portions.
State-Level FICA taxes
Additionally, some states impose their own FICA-like taxes, which can further increase the burden on self-employed individuals. It is important to understand these state-level taxes and ensure compliance to avoid any legal or financial issues.
Conclusion
Understanding self-employed income and the associated self-employment taxes is crucial for self-employed individuals to ensure compliance with tax laws. By being aware of the types of income considered self-employment income and the steps to report and pay taxes accordingly, individuals can avoid penalties and maintain their financial stability.