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.
This is a complex topic requiring analysis of many factors as outlined in the article.
S corporation owners are well-advised to evaluate and document their compensation policies at least annually to minimize their audit risk in this area.
Run around the block first. Look for a used vehicle. Is that BMW really going to make your life better? What will you be giving up to be driving a shiny hunk of metal and plastic that loses value every day of its existence?
Improve Your Finances By Modifying Your Behavior
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You don’t always get what you pay for but often you do.
One of my long time favorite “banking” institutions over the years has been the Dutch bank Ing. I have had a savings account with them for about 20 years. More recently I have opened a checking and brokerage (Sharebuider) accounts with them. Always appreciated that you could call them and immediately reach a human being who had a good grasp of the English language and how their accounts operate. This is so unlike so many big financial institutions these days and something I reward by refusing to maintain accounts with those entities that take their customers for granted.
With great trepidation I read recently that Ing Direct was acquired by Capital One Bank. Unlike Ing, I have thought of Capital One as a predatory financial institution. Their account offers in the past seem too often to have hidden fees with marketing pitches that turn out to be traps once they have a hold of your money or if you use their credit services.
Carefully Capital One will be watched to see if they mess up Ing. Just read an email from Capital One that they are adding the ability to scan deposits to the Ing accounts. That has the potential to be a great improvement and takes using Ing accounts to another level, not just to be used as a secondary account. Getting money directly into their accounts has always been one of the drawbacks of Ing accounts requiring another account to deposit into before making online transfers.
Best of luck to Capital One on their new acquisition. Don’t mess up a good thing please.
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