For some, calculating self-employment income is as easy as totaling up the amounts on their 1099-Misc forms, but for others, it's not that simple. And while you'll likely want to consult a tax specialist or the IRS about specific questions, this article goes over some of the basic points of self-employment income, so you can be more informed on your day-to-day business decisions.
How the IRS Defines Self-Employment Income
Self-employment income is earned from carrying on a "trade or business" as a sole proprietor, an independent contractor, or some form of partnership. To be considered a trade or business, an activity does not necessarily have to be profitable, and you do not have to work at it full time, but profit must be your motive. For those who don't have profit as a motive, an activity could be considered a hobby and not a business. However, the IRS defines a hobby narrowly, so be sure you understand the rules regarding profits and losses from a hobby.
The Difference Between Self-Employment and Employment
The IRS considers many factors when differentiating between activities it considers employment and contracting. Employees, even if they work at home, are not only directed by their employers in what work should be done but also how and when to do it. Employees usually receive regular paychecks, payroll taxes are taken out, and the employer pays half of their Medicare and Social Security taxes. Employees must earn minimum wage and will receive a W-2 at tax time.
Independent contractors are not as closely supervised as employees, though they may work in an office. They often, but not always, receive work on a project basis and may or may not be paid hourly. Independent contractors are not subject to minimum wage laws, and they pay all of their own Social Security and Medicare taxes, and they receive 1099-MISC, not a W-2.
Calculating Self-Employment Income
If you receive 1099 forms, tally up the totals in Box 7, titled "Nonemployee Compensation." You will only receive a 1099 form if you earned more than $600 from a company, but you'll still have to report all income less than that, so keep accurate financial records.
If you have a business that sells goods, you will need to calculate your gross income, which can be done by subtracting the cost of goods sold from revenue—taking into account returns and allowances. Keep accurate records and receipts to be sure you are accounting for all of your costs and sales. All of this is done on Schedule C.
Forms to Use
Most people will use the Schedule C form. If you're a farmer, you'll use Schedule F, and if your self-employment income comes from a partnership, you'll use Schedule K-1. After you've calculated your income, you will need Schedule SE to calculate the self-employment tax.
What Is Not Considered Self-Employment Income
Income for which you received a W-2—which would mean you are an employee—cannot be calculated as self-employment income. The same goes for income received from an activity that fits the narrow IRS definition of a hobby. Unless your self-employment involves dealing and brokering investment securities, interest and dividends are also not considered self-employment income.