Self-Employment Tax, Estimated Tax, AMT, NIIT, and Transfer Taxes

The rule: self-employment tax

A self-employed person owes self-employment (SE) tax — the combined employer and employee shares of Social Security and Medicare — once net earnings from self-employment reach $400 (a fixed statutory floor). The computation:

1. Net SE earnings × 92.35% (this 0.9235 factor approximates the employer-share deduction).
2. Apply 12.4% Social Security up to the annual wage base (indexed), and 2.9% Medicare with no ceiling — a combined 15.3% below the wage base.
3. Deduct one-half of SE tax as an adjustment to income (Chapter 3).

High earners also owe an Additional Medicare Tax of 0.9% on wages/SE income above a fixed (non-indexed) threshold that is not reduced for MFS.

Worked example — SE tax and its deduction

Nadia has $50,000 of net self-employment earnings (below the Social Security wage base).

• Taxable base = 50,000 × 0.9235 = $46,175.
• SE tax = 46,175 × 15.3% = $7,064.78.
• Above-the-line deduction = one-half = $3,532.39.

Worked example — the Additional Medicare Tax

A single filer has $250,000 of wages. The Additional Medicare Tax of 0.9% applies to wages over the $200,000 single threshold (fixed, not indexed; not reduced for MFS).

• Excess over threshold = 250,000 − 200,000 = $50,000.
• Additional Medicare Tax = 50,000 × 0.9% = $450.
• The employer must begin withholding the extra 0.9% once wages paid by that employer exceed $200,000, but the true liability is based on the taxpayer's total wages and SE income and is reconciled on Form 8959. A two-earner married couple can owe the tax even if neither employer withheld it, because each employer only looks at its own wages against the $200,000 trigger while the couple's MFJ threshold is $250,000 combined — a common under-withholding trap.

The rule: estimated tax and the safe harbors

Because SE income is not withheld, such taxpayers generally must pay quarterly estimated tax (Form 1040-ES) to avoid the §6654 underpayment penalty. A taxpayer must generally pay estimates if they expect to owe at least $1,000 after withholding and credits. The safe harbor is met by paying at least:

• 90% of the current year's tax, or
• 100% of the prior year's tax (110% if prior-year AGI exceeded $150,000).

Wage withholding is treated as paid evenly throughout the year, regardless of when it was actually withheld — a useful planning point.

Worked example — the estimated-tax safe harbor

Owen's prior-year AGI was $120,000 and his prior-year tax was $18,000. This year he expects tax of $25,000.

• 100%-of-prior-year safe harbor = $18,000 (his AGI was under $150,000, so 100%, not 110%).
• 90%-of-current safe harbor = 90% × 25,000 = $22,500.
• Owen pays the smaller target, $18,000, across four installments to be penalty-safe — even though he will owe $25,000, the $7,000 balance due at filing carries no §6654 penalty.

The rule: the AMT and the NIIT

Alternative Minimum Tax (AMT, §55, Form 6251) is a parallel tax: it recomputes income by adding back certain preferences and adjustments (private-activity muni-bond interest, certain depreciation, the standard deduction, and — before TCJA suspensions — some itemized items), subtracts an exemption that phases out at higher income, and applies AMT rates. You pay the AMT to the extent it exceeds your regular tax.

Net Investment Income Tax (NIIT, §1411) is a 3.8% surtax on the lesser of (a) net investment income or (b) the amount by which modified AGI exceeds a fixed threshold — $200,000 single / $250,000 MFJ / $125,000 MFS (these are statutory, not indexed).

Worked example — the NIIT

A married couple has MAGI of $300,000 and net investment income of $40,000.

• Excess MAGI over threshold = 300,000 − 250,000 = $50,000.
• NIIT base = lesser of $40,000 (NII) or $50,000 (excess) = $40,000.
• NIIT = 40,000 × 3.8% = $1,520.

The rule: estate and gift tax

The federal gift tax is generally paid by the donor, not the recipient. The annual gift-tax exclusion (indexed — verify) lets a donor give that amount of present-interest gifts to each of any number of recipients free of gift tax and without using the lifetime exemption; it applies only to gifts of a present interest, not future interests. Gifts between spouses who are both U.S. citizens are unlimited (the marital deduction). Married couples may elect gift-splitting to treat gifts as made half by each, doubling the annual exclusion. A donor may pay another's tuition or medical expenses without limit if paid directly to the institution or provider. The lifetime unified credit shelters a large (indexed) amount of cumulative gifts and estate transfers.

Worked example — gift-splitting

Grandpa wants to give $34,000 to each of his 3 grandchildren. Assume the annual exclusion is $18,000 per donee (verify current year).

• Alone, Grandpa's exclusion covers only $18,000 per grandchild; $16,000 each would be taxable gifts using his lifetime exemption.
• With gift-splitting, he and Grandma together exclude $36,000 per grandchild (2 × $18,000).
• Each $34,000 gift is fully covered; no taxable gift and no lifetime exemption used. (Grandma must consent, and a gift-tax return may still be filed to elect splitting.)

Worked example — how the AMT actually bites

The AMT catches taxpayers with large preference items relative to their regular tax. Suppose a taxpayer's regular taxable income produces a regular tax of $40,000. Recomputing for AMT, they add back a large amount of preference items (for example, a big deduction the regular system allowed but the AMT does not), arriving at alternative minimum taxable income that, after the AMT exemption (which phases out at higher income), yields a tentative minimum tax of $46,000.

• AMT owed = tentative minimum tax − regular tax = 46,000 − 40,000 = $6,000.
• The taxpayer pays the $6,000 AMT on top of the $40,000 regular tax, for $46,000 total.
• If the tentative minimum tax had been below $40,000, there would be no AMT — you pay the AMT only to the extent it exceeds regular tax. Report on Form 6251.

The rule: the federal estate tax

The estate tax reaches the transfer of wealth at death. The gross estate includes the FMV (at date of death, or the alternate valuation date six months later if elected) of everything the decedent owned or controlled — real estate, investments, business interests, life insurance the decedent owned, retirement accounts, and certain gifts made within three years of death. From the gross estate, the estate subtracts deductions to reach the taxable estate: funeral and administration expenses, debts, the unlimited marital deduction (transfers to a surviving U.S.-citizen spouse), and the charitable deduction. The estate then applies the unified credit, which shelters a large indexed exemption amount, and a surviving spouse may use portability to inherit the deceased spouse's unused exemption. Estate tax is reported on Form 706, due nine months after death (extendable).

Worked example — the marital deduction

A decedent leaves a $14 million gross estate: $9 million to a U.S.-citizen surviving spouse and $5 million to children.

• The $9 million to the spouse qualifies for the unlimited marital deduction → removed from the taxable estate.
• Taxable estate = $5 million, sheltered (in whole or part) by the unified credit's exemption amount (verify the current indexed figure).
• The lesson: the marital deduction can defer all estate tax to the second spouse's death, but does not eliminate it — planning weighs using each spouse's exemption against deferral.

Key figures — SE tax, estimates, AMT, NIIT, transfer taxes - SE tax floor: $400; base factor 92.35%; rates 12.4% SS (to wage base) + 2.9% Medicare (no cap) = 15.3%; deduct one-half. - Additional Medicare Tax: 0.9% over a fixed threshold; no employer match; not reduced for MFS. - Estimated-tax safe harbor: 90% current / 100% prior (110% if AGI > $150,000); must pay if owe ≥ $1,000. - NIIT: 3.8% over $200k single / $250k MFJ / $125k MFS (statutory). - Gift annual exclusion & lifetime exemption: indexed — verify; present-interest gifts only; spousal transfers unlimited (citizen); direct tuition/medical unlimited.

Common traps

• Forgetting the 92.35% factor before applying 15.3% to SE earnings.
• Applying 12.4% above the wage base — the Social Security portion stops at the wage base; Medicare continues.
• Using 110% of prior-year tax when AGI was under $150,000 — it is 100% then; 110% only applies above $150,000.
• Treating NIIT/Additional-Medicare thresholds as indexed — they are fixed statutory amounts.
• Thinking the donee pays gift tax — the donor does; and future-interest gifts do not qualify for the annual exclusion.

Check yourself

1. Net SE earnings are $80,000 (below the wage base). Compute SE tax.
2. A taxpayer's prior-year AGI was $200,000; prior-year tax $40,000. What is the prior-year safe-harbor payment target?
3. A single filer has MAGI of $250,000 and net investment income of $30,000. Compute the NIIT.
4. Who is primarily liable for federal gift tax?
5. Does paying a grandchild's college tuition directly to the university use the annual gift-tax exclusion?

Answers: 1. 80,000 × 0.9235 = $73,880; × 15.3% = $11,303.64. 2. 110% × 40,000 = $44,000 (AGI > $150,000). 3. Excess MAGI = 250,000 − 200,000 = $50,000; lesser of $30,000 and $50,000 = $30,000 × 3.8% = $1,140. 4. The donor. 5. No — direct tuition payments are an unlimited exclusion and use neither the annual exclusion nor the lifetime exemption.