Self-Employment Tax: Maximizing Benefits, Minimizing Costs

By Oliver, Joseph R. | The National Public Accountant, February 1995 | Go to article overview

Self-Employment Tax: Maximizing Benefits, Minimizing Costs


Oliver, Joseph R., The National Public Accountant


Determining a client's self-employment tax entails more than just completing Schedule SE.

In some cases, self-employment tax may be reduced by eliminating from the computation any earnings that are not subject to the tax or by shifting earnings between years or from one spouse to another. In certain circumstances, using an optional method for determining self-employment tax permits a client to continue Social Security benefit coverage despite low income or a loss for the year.

This article describes the different types of income exempt from self-employment tax, suggests ways in which net self-employment earnings may be reduced or shifted and explains when the optional methods for determining the tax are used.

Clients Not Subject to Self-Employment Tax

Certain taxpayers are partly or fully exempt from self-employment tax provisions. For example, the tax does not apply if net earnings from self-employment are less than $400.(1) Also, the tax is not applicable to nonresident aliens if they do not reside in the Virgin Islands, Guam, American Samoa or Puerto Rico. Aliens employed in the U.S. are exempt on salaries and wages from an international organization or a foreign government or wholly-owned instrumentality of one.(2)

A client who is conscientiously opposed to insurance benefits for disability, illness, death or retirement - based on the beliefs of a recognized religion - may file for exemption from self-employment tax (for church-related earnings only). Similarly, ministers and Christian Science practitioners may apply for exemption if they meet certain requirements. If a church or church-related organization elects exemption from Social Security taxes, employees who do not individually file for exemption generally owe self-employment tax.(3)

Income Not Subject to Self-Employment Tax

Although the trade or business income of a sole proprietor, independent contractor or partner generally is subject to self-employment tax, the following types of earnings are not.

* Most gains and losses on business assets;

* Gains and losses on sales, exchanges or other dispositions of business assets (including the recapture of depreciation) generally are not self-employment income unless the property is inventory or held primarily for sale to customers.

However, self-employment income does include amounts recaptured under Section 280F (listed property) and Section 179 (expensing of business assets) when business use of property declines to 50% or less. This is not a disposition of property.(4)

Example: In 1994, Maggie Martin bought $12,000 of equipment for use in her business, deducting the entire amount under Section 179. Early in 1995, Martin sells the equipment for $10,000, recapturing that amount under Section 1245. The $10,000 is not self-employment income.

Suppose instead that Martin shifts the property from use in her business to use on investment (nonbusiness) rental property. Because business use declines to 50% or less (actually, to zero here), the change triggers recapture of part of the $12,000 deduction under Section 179. The amount recaptured is self-employment income.

Most Interest, Dividends and Similar Income

Investment income such as interest, dividends and capital gains generally is not self-employment income. However, interest earned on business accounts and notes receivable generally is, as are interest and dividends earned by a dealer in stocks and securities.(5)

Investment Club Partners

Not all partnership income is self-employment income. A partner's share is excluded if an investment club partnership's activities are limited to investing in shares of stock and other securities and collecting interest and dividends for club members.

Most Real Estate Rentals

Real estate rentals are not self-employment income unless either of the following factors is present:(6)

* The landlord provides services not normally provided for occupancy only, such as maid service or access to a secretary. …

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