By Justin Ash
At year-end nearly all taxpayers drop off a bundle of paper work to their preparers and wait for the bill. One item of income however should receive some special consideration and planning. If you receive a Form 1099 reporting income from self- employment, the self-employment
tax bite is about 15% of the net income from the business (more if the business income triggers the net investment income tax). This is in addition to the regular income tax on the same amount. This makes it especially important to ensure that income is categorized correctly. Whether or not income is subject to
self-employment tax is dependent on all the facts and circumstances surrounding the issue. Engaging in a trade or business is characterized by ongoing efforts to earn a profit. Therefore, sporadic efforts, or activities that are unlikely to recur may escape the self- employment tax.
For example, let’s assume that Joe is a college student studying law. Joe is also very handy and was asked by his friend, Chris, to install a fence around Chris’ business premises for a price of $2,000. Joe does not hold himself out to be in the business of installing fences, he does not advertise his services, nor does he pursue fence installation through ongoing efforts to earn a profit. In this case, Chris would be required to issue a 1099-MISC to Joe with the amount of $2,000 reported as non- employee compensation in box 7 of that form. In this case Joe should be
able to avoid the self-employment tax on this amount because he is not engaging in ongoing efforts to earn a profit at fence installation.
Once you have determined that you are legitimately not subject to the self-employment tax there are a
couple of options when it comes to filing your return. You can report the income on line 21 of your 1040 as “other income not subject to self- employment tax”.
The safer alternative is to report the income as self-employment income, pay the tax, then amend your return and request a refund. This option is probably not necessary under most scenarios. However, it does offer the most protection because you are complying with the law and timely paying your tax, then subsequently requesting the refund after the government has time to analyze the situation. Under this option the worst that can happen is a denial of the refund. However, if you do not report the self-employment income as such and the IRS later re- characterizes it, you will be on the hook for interest, penalties, and potentially an additional penalty for under-reporting your income.
Keep in mind that a small change in the facts and circumstances surrounding the situation can have a large effect. Let’s assume that in our second example Joe is apprenticing under a general contractor to learn the construction trade and has taken out advertisements in a free local publication offering his handyman
services for hire. Joe also maintains a license with his local public works office authorizing him to install fencing (among other construction and repair type activities). Under this scenario Joe is liable for the self- employment tax and should report the income as gross receipts on his schedule C and deduct any ordinary and necessary business expenses against that income.
If you receive a 1099 and are unsure how to treat it please contact us. We can assist you with determining the proper treatment of the income and reducing any tax liability associated with it.