Do you owe the dreaded 15.3% self-employment (SE) tax on random non-employee earnings that you just solely acquire sometimes or in a one-off circumstance? Good query. This column explains why you in all probability don’t owe SE tax, after first overlaying some needed background data. Right here goes.
The dreaded self-employment tax
The SE tax is the best way the Feds acquire Social Safety and Medicare taxes on non-salary earnings from work-related actions. For 2019, the SE tax price is 15.3% on the primary $132,900 of web SE earnings. That 15.3% price is comprised of:
* 12.4% for the Social Safety tax part of the SE tax plus
* 2.9% for the Medicare tax part.
Above the $132,900 threshold, the Social Safety tax part goes away, however the 2.9% Medicare tax continues. And the Medicare tax rises to three.8% at increased earnings ranges. That 3.8% price then continues as much as web SE earnings of infinity.
Should you’re repeatedly self-employed, you recognize all this, and you intend for it. You should embody the SE tax hit together with your quarterly estimated federal earnings tax funds to keep away from an curiosity cost penalty. Price of doing enterprise.
However what in case you are not repeatedly self-employed, and also you earn some earnings from some random work or one-off circumstance that might be topic to SE tax if you happen to have been repeatedly self-employed within the exercise? Do you owe SE tax or not?
The reply: it’s essential to have interaction in commerce or enterprise to owe SE tax
You don’t owe SE tax until the earnings in query is from a commerce or enterprise. Based on a 1987 Supreme Court docket choice, meaning an exercise that you just conduct with continuity and regularity and with a revenue motive. Supply: Robert P. Groetzinger, 59 AFTR 2nd 87-532 (Supreme Court docket 1987).
So earnings earned from an remoted or sporadic exercise is mostly not topic to SE tax, as a result of the random exercise doesn’t rise to the extent of a commerce or enterprise. I dreamed up some examples to indicate how this customary would possibly apply in real-life conditions.
Instance 1: Your sideline job is much like your day job (Half 1)
You’re a self-employed development supervisor who works repeatedly for just some chosen development outfits that you recognize and love. You comply with supervise the development of your neighbor’s new dwelling in your “spare time” and acquire $25,000 to your efforts. Though such sideline work shouldn’t be one thing you do with any regularity (the truth is, you’ve by no means performed it earlier than in any respect), the sideline work is so carefully associated to your common self-employed work that you just in all probability owe SE tax on the $25,000. You may be fairly positive the IRS will make that declare if you happen to get audited.
Instance 2: Your sideline job is much like your day job (Half 2)
You’re employed by a development firm as a development supervisor. You comply with supervise the development of your neighbor’s new dwelling in your “spare time” and acquire $25,000 to your efforts. Though such sideline work shouldn’t be one thing you do with any regularity (the truth is, you’ve by no means performed it earlier than), the sideline work is so carefully associated to your common job as an worker of the development firm that the IRS would in all probability declare that you just owe SE tax on the $25,000. Why? Since you’re within the enterprise of being a development contractor — as an worker or in any other case. Nevertheless because you’ve by no means earlier than performed such work on a self-employed foundation, you would possibly beat the IRS if you happen to get audited on the problem and are prepared to struggle. It’s as much as you to resolve if taking the place that you just don’t owe SE tax on the $25,000 is well worth the danger.
Instance 3: A one-time realtor will get fortunate (Half 1)
You’re a former energetic realtor. For the previous few years, nevertheless, you’ve been a full-time house-husband caring for your younger children. However you’ve maintained your realtor license “just in case.” This yr you get fortunate and earn a $25,000 charge for referring an acquaintance to a different realtor who sells the acquaintance’s dwelling for giant bucks. Do you owe 15.3% SE tax on the $25,000 referral charge? I believe the reply is “No” as a result of you aren’t at present within the realtor enterprise. Should you get audited, the IRS would possibly disagree primarily based in your previous historical past as an energetic realtor. However if you happen to struggle, I guess you’ll win.
Instance 4: A one-time realtor will get fortunate (Half 2)
A number of years in the past, you dabbled as a part-time realtor, however misplaced curiosity after by no means making any actual cash at it. Nonetheless, you’ve maintained your realtor license “just in case.” This yr you get fortunate and earn a $25,000 charge for referring an acquaintance to a different realtor who sells the acquaintance’s dwelling for giant bucks. Do you owe 15.3% SE tax on the $25,000? I believe the reply this time is “No” past any shadow of a doubt.
What if you happen to get fortunate once more subsequent yr and earn one other $15,000 referral charge. Do you owe 15.3% SE tax on the $15,000? As soon as once more, I believe the reply is “No” past any shadow of a doubt.
Even if you happen to get fortunate yr after yr, I nonetheless don’t assume you owe SE tax on random referral charges that you just acquire simply by answering the telephone every now and then and making a name to a different realtor. This sporadic-at-best exercise shouldn’t be a commerce or enterprise, since you don’t do it with continuity and regularity. So IMHO you don’t owe SE tax on the referral charges. On this state of affairs of getting fortunate time and again, the IRS would possibly disagree. However if you happen to struggle, I guess you’ll win.
Actuality verify: You do owe earnings tax on random earnings
Simply because your random earnings is righteously exempt from SE tax — as a result of it’s not from a commerce or enterprise — doesn’t imply it is usually federal-income-tax-free. It isn’t. You should report random earnings on line 21 of Type 1040, Schedule 1 (Different Revenue and Changes to Revenue). You could owe state earnings tax too.
Lastly, if you happen to take the place that random earnings is SE-tax-exempt as a result of it’s not from a commerce or enterprise, you hand over the fitting to assert deductions for any associated bills. So our imaginary inactive however money-making realtors in Examples Three and Four can not write off their annual license charges and persevering with training bills paid to maintain their licenses in drive. Sorry.
The underside line
You now perceive that random earnings is normally SE-tax-exempt. After all, there are classes of non-random earnings which might be additionally SE-tax-exempt, reminiscent of billboard rental earnings the place your solely actual “work” is cashing checks. Seek the advice of your tax professional in case you are not sure about your SE tax publicity, however make clear that you just wish to be firmly satisfied that you just actually owe the tax earlier than coughing it up. It’s OK to be a reluctant taxpayer, so long as you abide by the principles.