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Reporting Self-Employment Income

There is oftentimes a thin line of distinction between a common-law employee and an independent contractor, and this distinction determines how you report income on your tax return. This article aims to clarify the distinction between an employee and an independent contractor, and in so doing, also aims to ensure that you gain a thorough understanding of how self-employment income is reported on your tax return, as opposed to how wages are reported.Self-Employment Income vs. Income from EmploymentFirst, we must make the very important distinction between a common-law employee, an independent contractor, and a self-employed individual.Common law employees
A common-law employee is a person who performs regular services for an employer, with the employer having the right to control and direct the results of the work, and the way in which it is done. For example, the employer: (a) provides the employee’s tools, materials, and workplace, and (b) can fire the employee. The employer withholds tax from an employee’s wages, and the employee reports wages directly on Form 1040, on line 7.Independent contractors
Unlike an employee, an independent contractor does not work regularly for an employer, but works as and when required. Independent contractors are usually paid on a freelance basis. An organization engaged in a trade or business that pays more than $600 to an independent contractor in one year, is required to report this to the IRS as well as to the independent contractor, using Form 1099-MISC. Independent contractors do not have income taxes withheld from their pay as regular employees do. The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work, and not what will be done and how it will be done. Independent contractors report their income initially on Schedule C, Profit or Loss From Business, or Schedule C-EZ,Net Profit From Businesses, then on Form 1040, line 12.

Self-employed individuals
A self-employed taxpayer is an individual who is in business for himself or herself, and whose business is not incorporated. You are considered self-employed if the following apply to you:
You carry on a trade or business as a sole proprietor.
You are an independent contractor.
You are a member of a partnership.
You are in business for yourself in any other way.An activity qualifies as a business if your primary purpose for engaging in it is for income and profit, and you are involved in the activity with continuity and regularity. An activity generally qualifies to be a business if you have made profits for three years out of the last five years.If you operate a business, you must report the income even if no reporting document (1099s) is received. You are a sole proprietor if you alone own a business, and the business is not incorporated. If you are an independent contractor, you are actually a sole proprietor.Self-employment income includes the following:
Income from sole proprietorship and non-employee compensation.
Corporate director’s fees.
Partnership income from a partnership operating a business (unless you are a limited partner).
Guaranteed payments from a partnership (including limited partners).
Bartering income.
Real estate rent, if received as a real estate dealer.
Income paid to retired insurance agents based on commissions received prior to retirement.
Newspaper vendor’s income, if vendor is 18 or over.
Interest received in a trade or business.
Net earnings of members of the clergy (unless taken a vow of poverty).
Gains or losses by a dealer in options and commodities.
A professional fiduciary who administers a deceased person’s estate.The following income is not considered self-employment income:
Shareholder’s share of an S corporation’s taxable income.
Fees received for services performed as a notary public.You must file a tax return if your net earnings from self-employment are at least $400.Statutory employees
A distinction must also be made between a self-employed individual and a statutory employee. A statutory employee is a person who is deemed to be an employee by statute. He/she is treated partly as being self-employed, and partly as an employee. Consequently, a statutory employee is: (a) treated as an employee for Social Security and Medicare purposes, and (b) treated as being self-employed for income tax purposes.An employer should indicate on the worker’s Form W-2 (box 13), whether the worker is classified as a statutory employee. Statutory employees report their wages, income, and allowable expenses on Schedule C or C-EZ. Statutory employees are not liable for self-employment tax, because their employers must treat them as employees for Social Security and Medicare tax purposes, and withhold these amounts.

Hobby income
A hobby is not considered a business because its activities are not carried on primarily to make a profit. If you earned income from a hobby, you must report that income on line 21 (Other Income) of Form 1040. You may report hobby expenses (but only up to the amount of hobby income) as a miscellaneous deduction on Schedule A, if you itemize deductions. If you do not itemize you cannot claim hobby expenses.Reporting Self-Employment ActivitiesYou report your income and expenses from self-employment on Schedule C, or Schedule C-EZ.You may be eligible to use Schedule C-EZ, which is an abbreviated version of Schedule C, if you have a profit from your business, and:
Your expenses are not greater than $5,000.
You have no employees.
You have no inventory.
You are not claiming depreciation, or claiming the business use of home deduction.Your net earnings (or loss) as figured on Schedule C, or your net earnings from Schedule C-EZ, are entered on line 12 of Form 1040. If you own more than one business, you must complete a separate Schedule C or C-EZ for each business. (Note that you cannot use Schedule C-EZ if you have a loss from your business.)