Self-employment tax is not always inevitable

When you receive a  Miscellaneous Income Form 1099-MISC with an amount in box 7, normally you must pay self-employment (SE) tax on this income.  The current self-employment tax rate is 15.3 percent. The rate is divided into two parts: 12.4 percent for social security and 2.9 percent for Medicare.

However it is not a foregone conclusion that this tax is always owed on this type of income.  As this article points out, the SE tax only applies to “net profit (unless it’s under $400) in a tax year, derived from a trade or business carried on by an individual as a sole proprietor or partner of a partnership (IRC § 1402(a), Treas. Reg. § 1.1401-1(c)).”

So when is self-employment not subject to the SE tax?  An example best illustrates this:

I am a Certified Public Accountant.  My primary line of work is performing tax compliance services.  My neighbor sees me painting my house one day, comes over and asks if I will paint his house also for a $2000 fee.  I have never received a fee for painting anyone’s house.  I agree to paint his house and he pays me the $2000.   My neighbor is required to issue a Form 1099-MISC with $2000 in box 7.

I am required to report this as income.  However I am not required to assess and pay the 15.3 percent SE tax on this income.  This is because I do not intend to paint anyone else’s house, I do not hold myself out as being in the painting business, painting is not related to my  line of work and I have not painted other houses in the past for a fee.

If an activity is unrelated to your regular line of work and “sporadic”, it is not subject to SE tax.  So what happens if I paint 2 houses instead of one?  How about three?

Unfortunately there is no clear line in the sand here.  Each situation requires analyzing the facts and determining whether sufficient evidence exists to classify an activity not as a business but rather as a sideline activity not subject to self-employment tax.

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