You create it. You sell. You pay tax.

Hi June,

I am a web designer ... 8+ years.

Hi June. I was directed to your site from a friend who spoke very highly of your tax knowledge for the self-employed :) Anyway, I have a situation where a website I created/owned was sold to an individual in Australia for a fairly substantial amount of money. Its come time where I need to file taxes, and I was wondering what you thought might be the best way to claim the sale.

I've been told either: long-term capital gain or self-employment income. The situation is fairly sketchy, as the person I sold to is unlikely to report the sale, so I have no forms, etc. I'd obviously like to be taxed the least amount possible :)

FYI: I ran the site for fun for about 1.5 years before the sale. It was an online deal-finding site, with social elements.

Thanks!
Pete
Palo Alto, CA


Dear Pete,

I assume you are a self-employed web designer. The site you sold is your creation and so it is taxable self-employed income to you.

Couple other things: The fact that nobody is going to get any paper saying that you sold it for $XX does not mean it's not taxable. If you don't claim the income it's fraud. That's really not good.

And, you guys got to watch out for all that tax advice you get from Aunt Tillie. Capital gains income. Good golly!

Check out this similar question: Indies: Your creation is your work and is subject to SE tax.

Best,
June

Indies: Your creation is your work and is subject to SE tax.

Hi June,

I'm typographer, graphic artist for 10+ years.

What a great website and I will look at your books/CDs.

I have a question. I make fonts. Other people sell my fonts on their websites. They send me royalty checks. Do I pay self employment tax on that royalty income? Most of my time is spent making fonts but I also do some logos and design work if that makes any difference.

Thank you SO much.
Rae
Madison, WI


Dear Rae,

Glad my site is helpful to you.

Yes, your income from font design is self-employed income and is subject to self-employment tax. Same with a musician who wrote a song and sold it or a writer who wrote a book and sold it. It's what you do to earn a living. It's your earned income.

Any royalties a self-employed artist receives for his work is self-employed income.

If you sold the wagon or bike cluttering your garage -- not self-employed income.

-- June

How does an indie pay Social Security Tax?

June --

I'm an independent military advisor ... have been for 3.5 weeks.

I have had one gig as an indie. I think I am going to be OK on income taxes. But I have searched your website, how do I make Social Security payments from my indie check? I tried to search your site to find the answer w/o bothering you, never could. I

Thanks in advance for you assistance,
Dean
Colorado Springs, CO


Hello Dean,


Good question. On their earned income, self-employeds, just as do employees, must pay three different taxes to the feds: income tax; social security tax ; medicare tax. Employees have these taxes withheld by their employers. The employer sends the withheld tax to the government.

For self-employeds social security tax and medicare tax are combined into self-employment tax. That's SE tax.

On a self-employed's federal tax return in addition to other forms there is a Form SE on which SE tax is calculated. SE tax is then combined with income tax liability to come up with total tax liability.

The calculation is done on the 1040 tax return and is paid via the tax return.

Be sure to read this post Estimated Taxes.

Best,
June

Reimbursements & SE Tax

June --

I have been a Consultant for 10 years.

Saw your comments on expenses going on a 1099. Yes you can deduct from your income tax but must pay SS and Medicare! 15.3% If you want to be fully reimbursed you have to ask for 18.1% more! Which I do. Pays for the extra SS/medicare tax on the extra amount being reimbursed!

What say?
Jerry


Jerry --

I say get the extra 18% if you can but your reasoning is incorrect.

You do not pay self-employment [SE] tax on gross income but on net self-employed income. Therefor you do not pay SE tax on reimbursements included on a 1099. This is how it works:

$2,500 REIMBURSEMENTS NOT ON 1099
10,000 gross income
1,000 non-reimbursed expenses get subtracted from your gross income
2,500 reimbursed expenses do NOT get subtracted from your gross income
---------
9,000 net income on which you pay SE tax


$2,500 REIMBURSEMENTS ARE INCLUDED ON 1099
12,500 gross income
1,000 non-reimbursed expenses get subtracted from your gross income
2,500 reimbursed expenses get subtracted from your gross income
---------
9,000 net income on which you pay SE tax

In states where there is a gross receipts tax read my posts on reimbursements and talk with your tax pro about special recordkeeping.

-- June

SE Tax: There's No PLace To Hide

June,

I have a question that I think is probably quite common. Is it wise to incorporate for the purpose of saving the 15% self-employment tax?

I have been operating as a self-employed person for a couple of years now and have read your book which says that most people don't need to incorporate, but I am confused now because many folks in my professional circle are saying they save money by incorporating because of this. I live in California.

What do you think?
Alexis


Hello Alexis,

There is a misconception about self-employment [SE] tax and incorporation. Actually there's a lot of cheating regarding SE tax and incorporation and the IRS is making headway to deal with it.

I know from previous correspondence with you that you are a web designer. So I will use you as an example with some oversimplified numbers and situaions.

If you work at your computer designing away for 40 hours a week at $50 per hour. You have gross income of $2000 a week. If you have $1000 a week expense you have a net income of $1000 a week. Let's say $50,000 per year. On that $50,000 you must pay SE tax whether you are an indie or an employee of your own corporation.

If you owned a domain name -- let's say gogreen.com -- that you bought for $100. That is an asset of your business. If a conservation organization bought it from you for $1000 you would have a $900 gain. You would not have to pay SE tax on that gain.

So you see the difference.

When people incorporate often they pretend that the income is not earned as it is with you sitting in front of your computer but that it is similar to the gain on the sale of the domain name. And that is how they avoid paying SE tax. In IRS circles it's called fraud.

Of course there is income that an indie may earn because of her reputation or her "name" that would not be subject to self-employment tax. In that case incorporation might be worthwhile.

Let's say web designers typically charge $50 per hour. But, you, Alexis Web Design, are known throughout the region and everyone wants Alexis as designer. So you raise your fee to $500 per hour. Then some of your income, were you incorporated, would not be subject to SE tax.

As I said, that is an oversimplified explanation but I hope it will give you a basic understanding.

-- June

How are your plumber and the Treasury Secretary nominee alike?

In the Daily Beast, Tina Brown tells us we are in the Age of Gigonomics and that the “gig economy is no picnic.”

The economy is changing. So much so that it affects people even in the corridors of power. And because it affects them, it’s news.

The most stunning revelation to come out of the hearings on the Timothy Geithner nomination for Treasury Secretary is that nobody who is anybody understands self-employment tax. The columnists, pundits, and reporters – they’re all in the dark. Even Rep. Barney Frank, speaking on MSNBC, when referring to the self-employment tax, added, “whatever that is.” And he’s chairman of the House Finance Committee, which deals with financial matters like taxes. And even Mr. Geithner’s three accountants – whom we expect are members of the Masters of the Universe -- didn’t quite understand it. Wow. This is news!

Well, not really. It might be news that all these high-placed people have fuzzy math when it comes to self-employment tax but freelancers know that they have always struggled with it as a component in the rules and regulations of being self-employed.

Who are freelancers? Freelancer is just another way of saying self-employed, 1099 person, sub-contractor, independent professional, indie, solo. In IRS talk they are “independent contractors.” And they have always had a more difficult time in the American economy than have employees.What’s an employee? Somebody who earns wages, a salary, or has take-home pay, who usually gets benefits like vacation pay or child care benefits or a pension contributed to by the company.

Part-time or fulltime does not determine your work status. A part-timer is not a self-employed. A self-employed can work a 60 hour week.

Artist are indies. So, too, are most psychologists and plumbers and tech consultants. The guys who work for Blackwater are indies. Most politicians upon leaving office for the talk circuit get paid as independents. Your landscaper and handyman are freelancers.

Most artists, for example, work on gigs as a matter of course. Often they work on multiple levels, dividing their time between commercial art and serious endeavor – such as musicians who play good-time Dixieland one night a week and innovative jazz on another night.

We respect artists in America – at least some of us do – but we don’t worry about the precarious state of their economic survival. It’s only when the same predicament hits the mainstream economy, as it is doing at present, that it becomes a perceived problem and a big story.

In her post, Tina conflates freelancers with part-time workers. They’re different. As corporations find it to their advantage to downsize by kicking employees out the front door and inviting them back in through the rear door as associates or consultants the long-standing muddle about self-employment and part-time work is growing more confused.

Most accountants who sit in mahogany offices – I personify the type in my book, Self-employed Tax Solutions, as Sammy Segar, CPA – are clueless about the freelance life. The tax laws are written for the corporate world, and they are trained solely in the tax structure of the corporate world. When they see an honorarium for a speech they treat it as “Other Income” rather than as “Earned Income.” And you know what? On earned income you must pay Social Security and Medicare taxes. If you’re an indie – same tax, different name. It’s called self-employment tax.

This apparently eluded the tax preparer who worked on Treasury Secretary-designate Timothy Geithner’s tax returns, and thus put his appointment to the Obama cabinet at risk. The state of the new economy means the accountants have to get out of their mahogany offices and into the present economy to see what self-employeds have been dealing with their entire indie lives.

Self-employed people get screwed not only by the accountants and the tax laws, but also by the banks, the mortgage brokers and all the other monotone gray elements of the corporate W-2 side of our economy. So maybe the grim economic forces that are creating a gig economy will at last help that unorganized and unorganizable mass of freelancers. Because so many people are scrambling into the same boat with freelancers, an opportunity has opened up for a New Deal for the Indies.

June Walker

Where are you getting your info?!

June --

Software Developer in my 3rd year.

I am currently a solo proprietor and would like to incorporate to avoid some of the self employment taxes.

If I do this in 2008 can ALL my income for 2008 fall under the incorporation or just the income that was earned after the incorporation?

Paul
Westminster, CO


Paul --

What do you mean by "avoid some of the self-employment tax?" Where did you ever get the idea that you would not have to pay self-employment [SE] tax if you incorporate? You haven't been getting tax advice from Aunt Tillie. Have you?

SE tax is made up of Social Security Tax and Medicare tax. You pay it on earned income whether you are self-employed or an employee -- even an employee of your own corporation.

Some people think that if they form an S-corporation and they make, let's say $40,000 as an IT consultant, that they claim only $10,000 of that as earned income and the rest as corporation profit. In that way they pay Social Security tax and Medicare tax on only the $10,000. That's cheating. And in legal circles it's called fraud.

Income earned before incorporating is not income to the corporation.

Best,
June

A Confused Investor

Hello June,

I've read your book, Self-employed Tax Solutions, and have visited your web site many times and have taken away much information. I am, however, looking for a little clarification on one issue.

I was self-employed as a Supervisor up until January of this year when my assignment ended. From that time on I have been making a living by trading options in the stock market. On one of your past answers you stated that the IRS does not consider you self-employed if you are living off investment income which is fine with me.

However, since I make around 30 trades a month and have projected a six figure income by next year, I have been told that the IRS will consider my efforts as being self-employed and I will have to pay SE tax. Do you agree?

Thanks for your time and useful information,
Bob Whitehall, PA


Hi Bob,

I think your are mixing apple stock with peach options.

Amount of investment income does not determine whether one is self-employed or not. The IRS may more readily scrutinize someone with substantial investment income and large self-employment losses over someone with the same losses but little or no investment income.

What I think you are asking is about someone who invests only for himself rather than someone who provides investment services for others. If you invest only for yourself you are not self employed no matter how many transactions nor how much money is involved. Your income is not subject to self- employment tax.

Take a look at these posts for more clarification INVESTOR-TRADER .

Best,
June

How does an indie pay social security tax?

June --

I am self-employed with no employees, however I am interested in paying something into the system toward social security benefits for myself in the future. What tax form do I fill out to get started?

Jane from Baltimore, MD


Hello Jane,

Every self-employed who has a net profit of $400 or more pays into social security when she files her tax return.The amount is figued on Schedule SE: Self-Employment Tax. Social security is part of self-employment [SE] tax.

-- June

SE Tax and Partnerships

Hi,

My husband currently receives a 1099 & is self-employed as a territorial sales rep.

He pays alot on self-employment [SE] tax. We are thinking about opening up a retail store in which we would be partners in an LLC.

Does The Small Business and Work Opportunity Tax Act of 2007 mean that we would not need to file for SE tax on this small business? If I am understanding it incorrectly & we still do need to file SE tax, is there some way we can combine his territorial sales rep work in which he already pays SE tax with the small retail business, so that we are not paying SE tax on two related businesses?


Also, does the Small Business and Work Opportunity Tax Act of 2007 eliminate the double taxation that occurs with husband & wife partnership llc's?

Thanks, Eileen


Hello Eileen,


Wow! You are mixing up apples, potatoes and Fruit Loops.

First of all, there is nothing in the Small Business and Work Opportunity Tax Act of 2007 that eliminates SE tax. To make sure there was no hidden paragraph that I missed I called the IRS to confirm. If you found something that says it's been eliminated, please send it to me.

Second: There is not now nor was there ever a double taxation of SE tax. Read What is Self-employment (SE) Tax? on this blog.

In a partnership SE tax is paid on the net profit. For instance, if you and a friend were 50/50 partners then each of you would pay SE tax on half the profit. A husband and wife partnership would also split the profit and pay SE tax on his and her share.

By the way, a partnership is the least tax advantageous business structure for a husband and wife business. A better way: One spouse as owner, the other as an employee.

Best,
June

What is Self-employment (SE) Tax?

While income tax is paid on any kind of taxable income, self-employment (SE) tax is paid only by people who work for themselves. SE tax is social security and Medicare tax for self-employeds and is paid on a self-employed’s net earnings.

Net earnings – think of it as net profit. It's what you have left after subtracting all business expenses from your gross self-employed income.

You must pay self-employment tax if net earnings from self-employment are $400 or more. The SE tax rate is 15.3% and is made up of two components: 12.4% social security tax plus 2.9% Medicare tax.

Social security benefits are available to self-employed persons just as they are to wage earners. Your payments of SE tax contribute to your coverage under the social security system which provides you with retirement, disability, and survivor benefits.

Medicare coverage provides hospital insurance benefits.

There is a cap on the amount of earned income on which you must pay social security tax. The cap for 2009 and 2010 is $106,800.

That means that you do not pay social security tax on income over $106,800. If you were to make $106,800 as an employee and also have an indie venture with a $20,000 profit, you would pay no social security tax on the $20,000 profit because you had already paid the maximum social security tax for 2009 or 2010 via withholding on your wages.

If you had a job and were also self-employed you would pay social security tax on both wages and profit until you met the $106,800 limit.

If you earn $106,800 in 2009 or 2010 you will pay the same amount of social security tax as Max Millionaire who earns $1,000,000. Hmmmm... do you see an opportunity here for filling the social security coffer?

There is no cap on Medicare tax. You pay 2.9% Medicare tax on all earned income.

{revised 1/31/10}

LLCs, Partnerships and Self-employment Tax

Rhonda from NY asked a multi-part question a while ago. One part of her question was answered here I am an LLC. How do I pay taxes? And now that I've successfully met the October 15 deadline for a lot of slow-to-get-to-it clients I can answer the other part of her question.

Rhonda's situation and questions are:

I am starting an LLC in NY with 2 other members. I am the managing member and the other 2 will not participate in management issues.

I understand I am subject to self employment [SE] taxes and they are not, but is this done only after profits/losses are distributed?

If the business has no net income, does that mean I pay no self-employment taxes?

I hope I did this the right way in leaving this question here and not posting a comment on line to you answer. This is my first time doing something like this and I do not know the "proper" procedures.

Again, thank you for you help.
Rhonda ... Bronx, NY


In a typical partnership, several people with different complementary skills get together to form a business. Rhonda doesn't say what kind of business they have formed so let's make one up to facilitate my examples. Since there are so many IT folks out there, I'll give Rhonda an IT business.

If all three participate in this business then they are all general partners. If they are equal partners each will share in 1/3 of the loss or 1/3 of the profit of the partnership. If the partnership has gross income of $50,000 and expenses of $20,000 then each would have income of $10,000 subject to income tax and SE tax. If the partnership had no profit, then there is no income or SE tax liability.

Profit is another way of saying net income -- that's gross income minus expenses -- and each partner will receive a partnership K-1 at year-end stating income and whether it is subject to SE tax or not.

An alternate scenario has Rhonda as the only one with technical skills and the only one to work for the partnership. Only her income is subject to SE tax. Partner #2 did nothing for the business other than contribute money and partner #3 did nothing for the business other than contribute equipment. Their partnership income was taxable but not subject to SE tax.

To recap: Simply not being part of management does not make the other partners exempt from SE tax. Their relationship to the partnership must be limited. That means they do not work in the partnership. For their portion of the partnership profit they may do things such as:
** Put in money
** Contribute equipment
** Loan a name or reputation
** Perform a specific service -- not related to the nature of the business, for instance -- legal or accounting, or logo design for which they'd receive a Form 1099-MISC from the partnership.

One last note: Of course, Rhonda should not set up an LLC and form a partnership without guidance from her tax pro.

June Walker

Notary Public / Court Reporter

Hi June,

Let me preface by saying, this year I attempted to do my own taxes through TurboTax to have a greater and deeper understanding of same; I believe that's the only reason that this was brought to my attention. I truly don't believe this question has ever been asked of me recently by any accountant that I've used.

There was a question regarding being a notary public and that any services as such were being performed as a public official and, therefore, those services were tax exempt.

As a court reporter it is my responsibility to swear in all witnesses and to then also certify every page of the transcript as being true and correct (also why I need to be a notary) as far as what was said, the parties present, events that happened, et cetera.

I feel that being a notary is an integral part of my job and, therefore, I am not sure if I should have to pay any self-employment tax. I have thought and thought about it and I don't see how you can separate out the two and I do believe my client pays me for both services being performed at the same time. If I were to lose my ability to be a Notary I would no longer be able to report. I looked on my previous tax years and I have always paid this self-employment tax.

Any guidance and standing I would have on this matter would be greatly appreciated. Thanks so much, in advance, for all of your time.

Sincerely, April in North Carolina



Hello April,

Public officials and public officers do not have to pay self-employment [SE] tax. There is no precise definition of "public official." The IRS says it is anyone who who administers or enforces public laws and exercises significant authority. . This includes positions such as governor, mayor, member of the state legislature or school board, justice of the peace, tax assessors.

A notary public, although she must pay income tax on fees earned, does not have to pay SE tax on income.

The IRS, on its website, gives the following examples of independent contractors: "People such as lawyers, contractors, subcontractors, public stenographers, and auctioneers who follow an independent trade, business, or profession in which they offer their services to the public, are generally not employees ... The earnings of a person who is working as an independent contractor are subject to Self-Employment (SE) tax."

A court reporter or stenographer who offers her services to attorneys or anyone else needing her services is considered self-employed, that's an independent contractor, and so does not get the exemption from SE tax that public officials get. A court reporter is not considered a public employee.

Here's a decision from a court case [Allen C. Moore and Annette Moore, plaintiffs v. U.S. defendant] in California in 1984: SE tax must be paid by court reporters who were also notary publics. The court reporter's services generated business fees subject to SE tax despite the practical necessity of being notary." Being "notary was merely incident to court reporting business."

I'm sure that's not the answer you want but it was a great question.

And, I'm glad you learned something from TurboTax, but, be careful. If you've read some of my other writing you know that many tax prep programs do not do the best job for indies.

Best,

June