If you are a self-employed individual, you are required to pay federal taxes depending upon the statutory requirements as stipulated by the IRS.
As per the IRS, a self-employed individual is one who carries on a trade or business as a sole proprietor or an independent contractor. Typically, a self-employed must pay income tax and self-employment tax to the IRS on the due date. Other types of business taxes that self-employed individuals may have to pay at the federal level include employment taxes and excise taxes if they meet the requirements for each of these taxes.
Income tax is the tax that you are required to pay as a self-employed if your net earnings from self-employment were $400 or more in the previous year. Even if your net earnings from self-employment were less than $400, you are still required to file an income tax return with the IRS, provided you meet the other filing requirements mentioned in the instructions to file Form 1040. You must file an income tax return in Form 1040 or Form 1040 SR along with Schedule C.
The other type of federal tax that you are typically required to pay as a self-employed individual is the self-employment tax (SE tax). The SE tax is a Social Security and Medicare tax that self-employed individuals, working for themselves, have to pay to the IRS. This is much like the social security and Medicare taxes that employers withhold from the pay of most wage earners. Thus, self-employed individuals must file Schedule SE along with Form 1040 or Form 1040-SR to pay their SE taxes.
In this article, we are going to discuss what is Form 1040 SE, who needs to file Schedule SE, and how to fill Form 1040 SE.
What Is Form 1040 SE?
Schedule SE is the Self-Employment Tax Form that all self-employed individuals must file along with Form 1040 or Form 1040-SR to account for the amount of self-employment taxes that they need to pay to the IRS.
What Is Self-Employment Tax?
Self-employment tax refers to the Social Security and Medicare Taxes primarily for individuals who work for themselves. It is much like the Social Security and Medicare taxes that employers withhold from the pay of most wage earners.
Note that in cases where the employers withhold Social Security and Medicare Taxes for the wage earners, the employers calculate this tax.
However, in case of the self-employed individuals, they themselves need to determine the self-employment tax (SE tax) using Schedule SE of Form 1040 or 1040-SR.
Moreover, while determining their self-employment tax, self-employed individuals need to deduct the employer-equivalent portion of their SE tax in figuring their adjusted gross income. But if we take the case of the wage earners, they cannot deduct Social Security and Medicare taxes on their own.
What this means is that only 92.35% of the self-employed earnings are subject to Social Security and Medicare taxes. This is because employers pay Federal Insurance Contributions Act (FICA) and Medicare taxes for each of their employees equal to 7.65% of the employee’s salary. Thus, that 7.65% is subtracted from the income of the self-employed to calculate their FICA and Medicare tax amount (100% – 7.65% = 92.35%).
The purpose behind deducting such a rate is that only 92.35% of the total self-employed earnings would have been the income of the self-employed individuals if they were employees. That’s because in such a case, their employer would have spent the other 7.65% on the tax.
Who Must Pay SE Tax?
All individuals must pay self-employment tax if:
- They had net earnings of $400 or more as a self-employed person. As mentioned earlier, self-employed individuals are those who are in the business, whether farm or non-farm, for themselves. Accordingly, self-employed individuals must also pay SE tax on their share of certain partnerships, in case they are in one, and their guaranteed payments.
- They had a church employee income of $108.28 or more. Church employee income refers to the wages that individuals receive as employees of a church (other than as a minister, member of a religious order, or Christian Science practitioner) or a qualified church-controlled organization that has a certificate in effect electing an exemption from employer social security and Medicare taxes.
- They had earned salaries and other income for services given as a minister, members of a religious order who hadn’t taken a vow of poverty, or Christian Science practitioners. Note that if individuals have ever filed Form 2031 to elect social security coverage on their earnings as a minister, they cannot revoke that election.
- They have earned income as a U.S. citizen employed by a foreign government for services performed in the United States, Puerto Rico, Guam, American Samoa, the Commonwealth of the Northern Mariana Islands, or the U.S. Virgin Islands. Individuals must report the income from this employment on line 2 of Schedule SE. However, if the individuals performed services elsewhere as an employee of a foreign government or an international organization, those earnings are exempt from SE tax.
- They are persons with dual U.S.-foreign citizenship as such persons are generally considered to be a U.S. citizen for social security purposes. However, if they are a U.S. citizen and also a citizen of a country with which the US has a bilateral social security agreement, other than Canada or Italy, their work for the government of that foreign country is exempt from the US Social Security taxes.
- They are self-employed U.S. citizens or resident aliens living outside the United States. Note that when determining the SE tax, self-employed U.S. citizens or resident aliens living outside the United States cannot reduce their foreign earnings from self-employment by their foreign earned income exclusion. However, there is an exception to this rule for which you must refer page 2 of SE instructions manual.
- They are self-employed nonresident aliens living in the United States provided an international social security agreement in effect claims that such individuals are covered under the U.S. social security system.
- They are a debtor in a chapter 11 bankruptcy case, their net profit or loss from self-employment won’t be included in their Form 1040 or Form 1040-SR income. Instead, it will be included on the income tax return (Form 1041) of the bankruptcy estate. However, such individuals are responsible for paying SE tax on their net earnings from self-employment.
- If they had two or more businesses subject to SE tax. In such a case, their net earnings from self-employment would be the combined net earnings from all of their businesses. If they suffer a loss in one business, it will reduce the income from another.
- If both spouses have SE income.
- If both the individuals and their spouses had community income and filed separate returns, attach Schedule SE to the return of each spouse with self-employment earnings under the rules described earlier
Who Must File Schedule SE?
All individuals must file Schedule SE if:
- Their net earnings from self-employment as showcased on line 4c of Schedule SE is $400 or more, or
- They had church employee income of $108.28 or more.
Note that if the individuals earned income through their services as a minister, member of a religious order, or Christian Science practitioner, such earnings would not be considered church employee income.
Who Should Not File Schedule SE?
The individuals should not file Schedule SE if they filed Form 4029 or Form 4361 and received IRS approval. On filing Form 4029 or Form 4361, the individuals are exempt from the SE tax.
Now when do individuals file Form 4029 or Form 4361?
Individuals are required to file Form 4029 if:
- They have conscientious objections to social security insurance as they have membership in and belief in the teachings of a religious sect recognized as being in existence at all times since December 31, 1950, and
- Such a belief has provided a reasonable level of living for the individuals’ dependent members.
Further, the individuals are required to file Form 4361 to apply for an exemption from SE tax if they have ministerial earnings and are:
- An ordained, commissioned, or licensed minister of a church;
- A member of a religious order who has not taken a vow of poverty; or
- A Christian Science practitioner.
How To Fill Form 1040 SE?
The following section gives general instructions on how to fill Form 1040 Schedule SE.
Line A is for those individuals who are ministers, members of a religious order, or Christian Science practitioners and they filed Form 4361 to apply for SE tax exemption. However, such individuals had $400 or more of other net earnings from self-employment. In this scenario, such individuals must check the box against Line A and continue with Part I of Form 1040 SE.
Line 1a and 1b
Line 1a represents the:
- Net farm profit or loss as reported on line 34 of Schedule F and
- Net farm profit or loss in case of farm partnerships as reported in Schedule K-1 of Form 1065, box 14, code A.
Note that partners use Schedule K-1 to report their share of the partnership’s income, deductions, credits, etc.
Further, if you are in the farm business, you must represent on line 1b the amount of the social security retirement or disability benefits that you in the farm business received as a part of the Conservation Reserve Program payments on Line 4b of Schedule F. Likewise, if you are in farm partnership, you must represent on line 1b the amount of the social security retirement or disability benefits that you in the farm business received as a part of the Conservation Reserve Program payments on box 20, code AH on Schedule K-1 of Form 1065.
Note that those of you who use the Farm Optional Method can skip lines 1a and 1b on Schedule SE of Form 1040.
Line 2 of this form represents:
- The Net profit or loss that you earn as a self-employed individual from operating a business or practicing a profession as a sole proprietor as reported on line 31 of Schedule C.
- Net profit or loss that you earn as a general partner from operating a partnership business, other than farming, as reported on box 14, code A of Schedule K-1, Form 1065.
For individuals who earned other income or were ministers or members of a religious order and wanted to report such income, they must see instructions of Schedule SE.
In addition to the above, you can also include the following on Line 2 of Schedule SE:
- The rental value of a home or an allowance for a home furnished to you including payments for utilities.
- The value of meals and lodging provided to you, your spouse, and your dependents for your employer’s convenience.
However, you need not include on line 2:
- Retirement benefits you received from a church plan after retirement, or
- The rental value of a home or an allowance for a home furnished to you including payments for utilities after retirement.
Note that if you were a duly ordained minister who was an employee of a church and you must pay SE tax, the unreimbursed business expenses that you incurred as a church employee are not deductible as an itemized deduction for income tax purposes. However, you must deduct the allowable expenses from your self-employment earnings on line 2 when determining SE tax and attach an explanation.
Also, if you were a U.S. citizen or resident alien serving outside the United States as a minister or member of a religious order and you must pay SE tax, you cannot reduce your net earnings by the foreign earned income exclusion or the foreign housing exclusion or deduction.
On Line 3, you must add all the amounts as represented against lines 1a, 1b, and 2.
Lines 4a Through 4c
Lines 4a through 4c will help you to determine whether you are liable to pay SE tax.
As mentioned earlier, only 92.35% of the self-employed earnings are subject to Social Security and Medicare taxes. Thus, in line 4a, you need to multiply line 3 by 92.35% (0.9235), provided line 3 is more than zero.
However, if line 4a is less than $400 due to Conservation Reserve Program payments on line 1b, then you must combine lines 1a and 2.
Then, if the total of lines 1a and 2 is $434 or more, you must file Schedule SE completed through line 4c with your tax return. Also, you must enter zero on line 4 of Schedule 2, Form 1040.
But, if the total of lines 1a and 2 is less than $434, you need not file Schedule SE unless you choose to use an optional method to figure your SE tax.
Further, if you also have church employee income, you need to complete lines 5a and 5b of Schedule SE. Also, you must complete the rest of Schedule SE as appropriate.
In Line 4b, you must enter the total of lines 15 and 17, provided you elect one or both of the optional methods.
What Are Optional Methods?
There are two optional methods to determine net earnings from self-employment.
- Farm Optional Method
You may use farm optional method to determine your net earnings from farm self-employment if your:
- Gross farm income was $9,060 or less or
- Net farm profits were less than $6,540
Net farm profits are nothing but the difference between:
- The total of the amounts from line 34 of Schedule F of Form 1040 and box 14, code A, of Schedule K-1 of Form 1065 and
- The amount you would have entered on Schedule SE, line 1b, had you not used the optional method.
If you use the Farm Optional Method to determine your net earnings from farm self-employment, then you must report two-thirds of your gross farm income, up to maximum of $6,040, as your net earnings on line 15 in Part II of Schedule SE.
Note that this method can increase or decrease your net earnings from farm self-employment even if the farming business had a loss.
Furthermore, if you had a farm partnership, you must determine your share of gross income based on the partnership agreement. In case you receive guaranteed payments, in such a scenario, your share of the partnership’s gross income will be the sum of your guaranteed payments and your share of the gross income after it is reduced by all guaranteed payments made by the partnership. If you are a limited partner, include only guaranteed payments for services you actually rendered to or on behalf of the partnership.
- Nonfarm Optional Method
You may use Nonfarm Optional method to determine your net earnings from nonfarm self-employment if your:
- Net nonfarm profits were less than $6,540 and also less than 72.189% of your gross nonfarm income.
- Actual net earnings from self-employment were $400 or more in 2 of the 3 prior years.
Here, net nonfarm profits are nothing but the total of the amounts from:
- Line 31 of Schedule C (Form 1040) and
- Box 14, code A of Schedule K-1 of Form 1065 (from other than farm partnerships).
You can use the Nonfarm Optional Method only if you are regularly self-employed.
Note that you will be considered as regularly self-employed if your actual net earnings from self-employment were $400 or more in 2 of the 3 years before the year you use the nonfarm optional method.
Further, the net earnings of $400 or more can be from either farm or nonfarm earnings, or both. Also, the net earnings include your distributive share of partnership income or loss subject to SE tax.
Remember, you can use the nonfarm optional method to determine your self-employment earnings for only 5 years. Further, it s not mandatory that these 5 years have to be consecutive.
Also note that if you use nonfarm optional method to determine your net earnings from nonfarm self employment, you must report two-thirds of your gross nonfarm income, up to the amount on line 16, as your net earnings on line 17 in Part II.
But you cannot report less than your actual net earnings from nonfarm self-employment.
Furthermore, you must determine your share of gross income from a nonfarm partnership in the same manner as a farm partnership.
In Line 4c, you must combine the amounts as against lines 4a and 4b. If this amount is less than $400, then you must stop here as you don’t owe any self-employment tax. There’s an exception here. If the amount in line 4c is less than $400 and you had church employee income, then you must enter zero here and continue filling the form.
Lines 5a to 5b
You must fill this section if you had church employee income. To fill this section, you must refer your Form W-2 for church employee income and enter the amount on line 5a.
Then on line 5b, you must multiply line 5a by 92.35% (0.9235). If this amount turns out to be less than $100, you must enter zero.
On line 6 of Schedule SE, you must enter the amount that is the sum of the amounts as reported on lines 4c and 5b. Thus, the resulting amount would include the required farm income, nonfarm income, and the church income needed for calculating the self-employment tax.
On line 7, report the maximum amount of combined wages and self-employment earnings that are subject to social security tax or the 6.2% portion of the 7.65% railroad retirement (tier 1) tax for the taxable year.
Note that as per IRS, the maximum amount of self-employment income subject to social security tax is $147,000. For 2022, put $1,47,000 on line 7.
Lines 8a Through 9
On line 8a of Schedule SE, showcase the total social security wages and tips. This is nothing but the total of boxes 3 and 7 on Form(s) W-2 and railroad retirement (tier 1) compensation. If this total turns out to be $147,000 or more, then skip lines 8b through 10, and go to line 11.
Then, on Line 8b, showcase the unreported tips subject to social security tax from line 10 of Form 4137.
Further, on line 8c, report the wages subject to social security tax from line 10 of Form 8919.
Finally, on line 8d, add lines 8a, 8b, and 8c.
On line 9, subtract line 8d from line 7. If the resulting amount turns out to be zero or less, then enter 0 here and on line 10 and go to line 11.
On line 10 of Schedule SE, multiply the smaller of line 6 or line 9 by 12.4% (0.124). Here 12.4% represents the social security tax.
On line 11 of Schedule SE, multiply line 6 by 2.9% (0.029) . Here 2.9% represents the medicare tax.
Line 12 of Shedule SE represents the self-employment tax. To report this tax, add lines 10 and 11. Enter the resulting amount here and on line 4 of Schedule 2 of Form 1040.
As a self-employed individual, you can claim a deduction for one-half of the self-employment tax at the time of filing your income tax return with the IRS. To calculate this deduction, you must multiply line 12 by 50% (0.50). Enter the resulting amount here and on line 15 of Schedule 1 of Form 1040.
Part II of Schedule SE represents the section where you can choose to use different optional methods to determine your net earnings from self-employment.
Lines 14 and 15 represent the farm optional method and lines 16 and 17 represent the nonfarm optional method.
You may use this method only if your:
- Gross farm income as reported on line 9 of Schedule F and on box 14, code B of Schedule K-1 of Form 1065 wasn’t more than $9,060, or
- Net farm profits, as reported on line 34 of Schedule F and box 14, code A of Schedule K-1 of Form 1065 less the amount you would have entered on line 1b had you not used the optional method, were less than $6,540.
Line 14 of Part II represents the maximum income for optional methods and that is $6,040.
This section of Part II of Schedule SE represents the amount that is smaller of:
- Two-thirds ( 2/3) of gross farm income but not less than zero or
- The maximum income for optional methods, that is, $6,040
Lines 16 and 17 represent the nonfarm optional method.
You may use this method only if:
- Your net nonfarm profits, as reported on line 31 of Schedule C and box 14, code A of Schedule K-1 of Form 1065), were less than $6,540 and also less than 72.189% of your gross nonfarm income, as reported on line 7 of Schedule C and box 14, code C of Schedule K-1 of Form 1065, and
- You had net earnings from self-employment of at least $400 in 2 of the prior 3 years
In Part II, line 16 represents the difference between:
- The amount that stands against line 15 and
- The maximum income for optional methods, that is, $6,040 as presented on line 14
In Part II, line 17 enter the amount that is smaller of:
- Two-thirds ( 2/3) of gross nonfarm income but not less than zero or
- The amount on line 16