The question often arises as to just exactly when does the “self-employment tax” apply? After all, since this exaction clips folks at over 15% of the income in question, the answer often will mean “real money” coming out of the taxpayer’s pocket.
Generally, the self-employment tax applies to net profit (if $400 or more) derived from a “trade or business” carried on by a sole proprietor. But the determination as to whether one is engaged in a “trade or business” sometimes is open to interpretation — and dependent upon all of the “facts and circumstances” surrounding the situation.
Activities performed as an employee do not constitute self-employment, though employees obviously bear the equivalent burden of the FICA (and Medicare) taxes.
Carrying on a “trade or business” implies the taxpayer is expending his or her effort, though sporadic efforts may not qualify. Consider Rev Rul 58-112, dealing with payment of a commission to a corporate officer to negotiate the sale of his company to the payor. IRS ruled, in this case, that the chap receiving these payments did not derive self-employment income because he had never previously engaged in a similar transaction, and did not hold himself out as available for such negotiations.
Contrast this example to the case of an executive who serves on a Board of Directors and receives directors’ fees — IRS says this activity typically does give rise to self-employment income.
(Learn more: Why the Self-Employed May Be Audit Targets.)