Self-Employment or Other Income?

How to avoid the cost of self-employment tax.

July 2009
by Jennifer Spiesz and Charles Harter/Journal of Accountancy

Taxpayers frequently have income reported on Form 1099-MISC. It may represent earnings from a trade or business that should be reported on Form 1040, Schedule C. If not, it generally is reported as other income on Form 1040. Of course, net income from a trade or business is subject to both income tax and the 15.3 percent self-employment tax, while other income generally is subject only to income tax.

However, while taxpayers can deduct a net operating loss from a trade or business, they may deduct their expenses incurred in generating other income only up to the amount of that income. Consequently, tax preparers must be able to determine whether income is trade or business income or other income, which isn’t always easy.

Trade or Business

A trade or business has been defined as “holding one’s self out to others as engaged in the selling of goods or services.” (Deputy v. du Pont, 308 U.S. 488 (1940), Frankfurter, J., concurring). The Small Business/Self- Employed section of the IRS Website defines it as “an activity carried on for a livelihood or in good faith to make a profit.” Revenue Ruling 58-112 further characterizes a trade or business activity as one that is regular, frequent and continuous. The regularity of activities and transactions and the production of income are important elements. Taxpayers do not need to make a profit to be in a trade or business as long as they are able to earn a profit and have a good-faith motive to do so. They must, moreover, make ongoing efforts to further the interests of the business.

This article has been excerpted from the Journal of Accountancy. View the full article here.