The type of business you own and operate could determine whether you need to file and pay self-employment taxes. The Internal Revenue Service’s website notes that work performed as a sole proprietorship or an independent contractor generally requires filing annual business tax returns.
Independent contractors and sole proprietors may also have an obligation to pay estimated quarterly taxes. These taxes contribute to the Social Security and Medicare trust funds. Individuals who have contributed to these funds may apply for benefits when retiring or if they become disabled.
Profit-and-loss filings versus self-employment tax
The IRS notes that business owners must first determine their net profits or net losses before submitting income tax returns. If your annual net profit exceeds $400, the IRS may require filing business tax returns.
Sole proprietors and independent contractors generally include their business’s profit-and-loss figures on Schedule C. Whether you need to pay quarterly self-employment taxes may depend on your business activities. Your profit-and-loss figures could determine the outcome.
Hobbies versus active businesses engaged in profit-making
If audited for self-employment tax purposes, the IRS may conduct a thorough review of your business. An agent may wish to learn whether your activities classify as a hobby or an income-producing enterprise. Kiplinger’s Personal Finance reports that the IRS looks at large loss-producing activities that offset income and business earnings. If an enterprise appears to function more as a hobby than an income-producer, the IRS could disallow deductions.
The IRS may ask taxpayers to prove the purpose of their business activities. Keeping track of legitimate expenses such as insurance and self-employment tax returns may confirm that you own an enterprise designed for profit-making.
Business owners may have an obligation to pay self-employment taxes as part of their regular income tax filing requirements. Taxpayers, however, have a right to challenge or appeal issues related to tax controversies.