Self-Employment Tax

Brand-new business owners are sometimes surprised to find out that in addition to their federal income taxes, they must also pay a significant percentage of their income to the government in the form of Self-Employment Contribution Act (SECA) taxes.

The SECA tax is basically the business owner's version of the FICA tax that employees pay. Like FICA, it is made up of your "contributions" to both the Social Security and Medicare programs. However, the basic tax rate for the self-employed under SECA is 15.30 percent (twice the 7.65 percent rate that employees must pay on their paychecks as FICA tax) to reflect the fact that employees pay one-half the FICA tax and employers pay the other half.

Reduced Rates for 2011 and 2012 Only. The SECA tax rate is 13.30 for 2011 and 2012. This reduction is to ensure that self-employed individuals have a comparable benefit to the payroll tax reduction that employees will enjoy during this period. For 2011 and 2012, the employee's portion of the Old Age, Survivors and Disability Income (OASDI) tax was reduced from 6.2 percent of wages to 4.2 percent of wages. The employer's portion remained at 6.2 percent of wages, and the employee and employer Hospital Insurance tax (Medicare) remained at 1.45 each.

In 2013, the employee's portion of FICA reverted to the 6.2 percent rate on March 1, 2012. And, the SECA rate reverted to 15.30 percent as of that date.

Warning Beginning in 2013, there is a Medicare surtax of 0.9 percent imposed upon earnings over a threshhold based on your filing status. There is no cap on the amount of earning subject to this new tax. The thresholds triggered the additional 0.9 percent liabililty are $200,000 for single taxpayers; $250,000 for married filing jointly and $125,000 for married, filing separately.

What income counts? For starters, you don't have to worry about paying the SECA tax at all if your total business income, from all Schedule Cs combined and from any partnership or S corporation income that is treated as self-employment income, is less than $400. But if your total income is $400 or more, you must file a Schedule SE and pay SECA tax on your entire net business income, including the first $400.

If you are filing jointly and your spouse also files one or more Schedule Cs, each spouse must count his or her own income separately.

You own two small businesses and file two Schedule Cs. Business A had net income of $80,000 and Business B had a net loss of $5,000. Your spouse also operated a business as a sole proprietor, and had net income of $20,000. On Line 12 of your Form 1040, you would report all schedule C income earned by both you and your spouse: $80,000 + $20,000 - $5,000 = $95,000. However, for SECA tax purposes, your total net business income would be $80,000 - $5,000 = $75,000. Your spouse's total net income for SECA purposes would be $20,000. You must each file one Schedule SE and attach both of them to your joint Form 1040.

Since it's the net income from your business that is the basis of SECA tax, certain types of income are not included: interest and dividends, sales of business property or other assets, and rental income from real estate or personal property. There's an exception to this rule if generating that income is your core business; for instance, if you are a real estate developer in the business of renting or selling property, you operate a bank, or you are in the rent-to-own business. Do not count any income from your hobbies.

Some special rules apply to the following:

• partnership distributions
• corporate payments
• religious exemption income
• aliens' income
• miscellaneous income

Once you know what types of income to count, you can:

• apply the annual limitation on income subject to SECA tax
• compute your SECA tax

Among the Business Tools are Form 1040, Schedule C and Schedule SE. They are in Adobe Portable Document Format (.pdf), and you will need the free Acrobat Reader to view and print the file.