Fed tax question: self-employment penalty

[Broomstick]

@tralfamidor

My nephew made the princely sum of roughly $7,000 last year. He correctly calculated that he would owe minimal federal tax (I think it was less than zero after the earned income credit), but he was horrified to learn that he owed the gummint $1100 in social security self-employment punishment tax. He had to sell his computer to raise the money–and working on his computer was how he had earned that $7000 in the first place :mad: (And yes yes yes, he should have known about this beforehand and set the money aside.)

He wasn’t screwed at all. He did bump into reality.

It is NOT a “punishment tax”!

Here’s the thing: an employee pays X amount of social security tax. An employer also pay X amount of social security tax for that worker, the exact same amount.

When you are self-employed you are BOTH the employee and the employer, so you pay both the employee’s X and the employer’s X.

Yes, it does catch a LOT of people because so many have only worked for others and often aren’t aware that employers also pay this tax.

It seemed ludicrous–and unfair–to me that someone who hadn’t earned even close to the poverty level nonetheless owed $1100 in taxes. Does anyone know of any way around this for low income earners, or is my nephew screwed like everyone else?

No, there is no exception for low income earners.

And no, he’s not “screwed” and neither is anyone else. If you are going to be an employer you have to pay the same tax as your employees, and when you’re both employer and employed (that is, self-employed) yes, you pay twice.

I work as an “independent contractor” as well, and I put that in quotation marks because I have worked for a number of entities in what was clearly an employer-employee relationship (they told me when and where I had to do the work, they had extensive rules about how I would do the work, etc.), but they called me an IC in order to stick me with the employer half of SSI. I couldn’t find a fix for that, either–I had to cough up a huge amount at the end of the year (I filed 1040, Schedule C).

If they did, indeed, do that recently it is now illegal. If they did it before the law was changed there is nothing to be done. The only way to get a definitive answer would be to hire a tax lawyer which is, admittedly, expensive.

[pulykamell]

@Alley_Dweller

You only have to pay 90% if you choose to use the current year’s taxes method. You can also pay 100% (or 110% for some high income earners) of your previous year’s taxes in four equal installments, completely disregarding this year’s taxes, or you can choose to calculate your actual annualized taxes every quarter and make unequal payments based on that.

Yes, sorry if I was unclear. The 90% was supposed to refer to estimating this year’s taxes, not using last year’s (where the 100% or 110% number is in play.) I always do the latter, because it’s so much less of a hassle. (And in those years where my income grows, it’s of course better, as long as you save your tax money and not blow it. Why give the gov a free loan?)

[Alley_Dweller]

@pulykamell

Yes, sorry if I was unclear. The 90% was supposed to refer to estimating this year’s taxes, not using last year’s (where the 100% or 110% number is in play.) I always do the latter, because it’s so much less of a hassle. (And in those years where my income grows, it’s of course better, as long as you save your tax money and not blow it. Why give the gov a free loan?)

Agreed.

[Broomstick]

@tralfamidor

So you think it’s fair that he has to pay twice what “regular” earners pay? OK, obviously you do.

He is not paying twice what “regular” earners pay. His employee’s share is calculated exactly the same as if were a “regular” earner. And, because he is ALSO an employer his employer’s share is also calculated exactly the same as for other employer’s.

(And people wonder why I’m not eager to be an entrepreneur…)

[Broomstick]

@pulykamell

Ah, I missed the seasonal aspect of this.

Yes, the payments are usually equal and have to total 90% of the total tax liability to avoid a penalty. So basically you have to pay at least 22.5% of your annual tax liability to be in the clear. I think there may be exceptions for unexpected earnings, but I am not an accountant.

I think there is some sort of work-around for work that is actually seasonal. I know there are separate rules for farmers and agricultural workers, but what exactly I’m not familar with.

Frankly, anyone working self-employed, whether as primary income or on the side, even if the total gross is below the poverty line, really should speak with an accountant, CPA level or higher. An hour or two can alert you to pitfalls to avoid, how to properly document your expenses, account for your finances, and how much to set aside in anticipation of taxes. Even though I’ve been living below the poverty line for the past 6 years I have still had an accountant do my taxes and advise me every year. And it’s worth every penny because my records are organized, my taxes are done properly, and I don’t have financial upsets due to surprises at tax time.

As an example, in addition to scrabbling for for work for 4 of those 6 years, I also ran a lawn-mowing/landscape maintenance business as a sideline in summer. Never earned huge amounts, but I was able to deduct the gas I bought, mileage on my truck, all other needed supplies (trash/lawn bags, work gloves, a rake, a broom…) This reduce the tax liability for the side business, which reduced how much I had to pay in taxes on the profits. Before I started that sort of work I sent the accountant an e-mail and he reminded me about what could be deducted and what to keep records of.

Back when I was in a situation where I had to pay quarterly taxes even as a “regular” employee (I was living in one state and working in another, and the employer so screwed up this that I said “eff that” and started doing my own state withholding just so it would be done right) he also advised me on how to do that, and how much to pay quarterly each year.

And really, the nephew mentioned in the OP should have been utilizing his computer as a depreciating piece of machinery for his business. I don’t know what the kid was doing for his business, but I suspect he was missing a lot of other deductions. I don’t know if he’d think it was worth it or not, but he might be able to amend his taxes for that year - but for that he really does need to speak with a tax professional in real life.

[DrDeth]

There actually is a exception for low earners. If you net under $400.00 you don’t owe SE tax.

And, the IRS is very easy on low earners and would allow him quite a bit of time to pay.

[pulykamell]

@Broomstick

I think there is some sort of work-around for work that is actually seasonal.

Yeah, Alley Dweller mentions it in post #39. Looks like it requires some additional paperwork, but can be done.

[Terr]

@Alley_Dweller

Keep in mind that dividend payments are not a deductible expense for corporations. That is why many complain about what they call the double taxation of dividends.

And you can also get in trouble for not paying yourself a reasonable salary. Of course, “reasonable” is subject to interpretation.

Dangerosa meant distributions (from an S corporation), not dividends. And “reasonable” can be quite a bit lower than the total income.

[Terr]

@drachillix

Same scenario, the corp would be paying the other half and the corp takes all the deductions not you. You just become a guy with a paycheck.

The same amount of money goes out, just now half comes from your paycheck and the other half comes from the company coffer. You do not save anything.

You have an S corporation. You earn, net, 100K. You pay yourself the salary of $40K, on which you have to pay full 15%+ FICA. The other 60K you give yourself as “distributions”. No FICA needs to be paid on that.