The Internal Revenue Code clearly states that an individual must carry on a trade or business, either as an individual or as a member of a partnership or limited liability company treated as a partnership, to have net earnings from self-employment.
In addition, the code states, thus, a person whose activities do not rise to the level of a trade or business for purposes of deducting trade or business expenses is not engaged in a trade or business for purposes of the self-employment tax.
In both cases referenced here the taxpayers received income that was NOT from a trade or business. The key to defending these cases rested with the fact that in order for income to be subject to self-employment tax, the income must be derived from a trade or business. Whether a particular activity is a trade or business is a question of fact. An activity is generally considered a trade or business if it is engaged in regularly and for profit. Whether the taxpayer holds him or herself out to the public as providing goods or services is also a factor.
Clearly in both cases the taxpayers were not involved in a trade or business and did not hold themselves out to the public as providing goods or services.
If you receive a letter from the IRS that proposes adjustments or changes to your tax return, you really should consult an EA, CPA or attorney, unless you fully understand the technical aspects of the issues. Quite often we see IRS letters that simply require a written response explaining the facts in order to resolve the matter. The IRS will send a follow up letter accepting the explanation and withdrawing their proposed adjustment.
Most people don't realize that more times than not, the IRS letter is computer generated (a human being has not reviewed the issues prior to the computer spitting out a letter to the taxpayer). I believe the IRS spent $9 Billion Dollars on their computer systems in the last ten years, and as good as the system is (and it is good), it is not always correct.More About IRS Letters