As of 2020 in the United States, there are 24.8 million self-employed individuals. Another 6 million self-employed owners have small businesses that employ other people. Obviously, we Americans love being our own boss.
Self employment means working for oneself rather than for an employer, and it is significant in distinguishing between business owners and self-employed individuals. The IRS criteria for self-employment help lay the groundwork for understanding the various types of self-employment.
This article will supply you with a framework to decide whether self-employment is right for you, including the advantages, disadvantages, tax implications, and more.
What is Self Employment?
The common definition of self-employment is that you work for yourself, full-time or part-time. You earn money from customers or clients who pay you, instead of earning wages or salary from an employer.
The Internal Revenue Service’s definition of self-employed is that you carry on a trade or business as a sole proprietor or independent contractor. The IRS also considers you self-employed if you are a partner in a business partnership, or if you are otherwise in business for yourself.
Self-employed people enjoy the freedom and flexibility of being their own boss, but they also need strong financial management and administrative skills to handle income variability and expenses.
What are the Types of Self-Employment?
The IRS expressly includes a worker in the gig economy among the types of self-employment. Gig workers include Uber or Lyft drivers, delivery persons using platforms like DoorDash, freelancers on digital platforms like Fiverr or Upwork, as well as those who sell crafts and handmade items on marketplaces like Etsy.
Other terms used to describe self-employed roles include independent contractors, entrepreneurs and small business owners.
Specific types of self-employment include hairstyling, social media consulting, personal training, handyman, landscaper and cleaning services. But you are not limited to providing a service. A self-employed individual might manufacture a product, develop software, sell real estate, manage investments, be a copywriter, sell in retail, or be involved in thousands of industries. See more types in our list of self-employed jobs.
When reporting self-employment income, individuals can deduct health insurance premiums from their taxable income, which highlights a significant financial benefit available to self-employed individuals.
Advantages and Disadvantages of Self-Employment
The advantages of self-employment include independence, autonomy and flexibility:
- You are in charge and make all decisions.
- You establish your own hours and workplace.
- Your earnings opportunity is limited only by your ability and performance.
The disadvantages of self-employment include risks and uncertainties:
- Your earnings may fluctuate.
- You are responsible for acquiring new clients or customers and generating all revenues.
- Tax compliance is more complex. You must pay the self-employment tax (i.e., the full social security and medicare tax). It is essential to keep accurate records. Additionally, you may need to pay estimated taxes each quarter to meet your tax obligations.
How Do I Qualify to Be Self-Employed?
Anyone in the United States can be self-employed. The only criteria are your own skills and desires.
A business entity is a legal structure under which a business operates. Different structures, such as sole proprietorships and limited liability companies (LLCs), impact self-employment differently. In a sole proprietorship, the owner and the business are the same entity, which means the owner’s personal liability is directly tied to business losses. In contrast, LLCs are separate business entities that offer legal protections to their owners, thereby mitigating personal financial risk.
It’s a good idea to make sure working for yourself is a good fit for your personality and circumstances, by asking these questions:
- Am I enough of a self-starter to seek out customers and revenue on my own?
- Am I willing to do whatever it takes, including emptying the trash and keeping the books?
- Can my family and I live without a steady paycheck, knowing my income may be uncertain at first?
You may answer yes to each question but still feel uncertain. That’s normal. Most people recognize they are taking a risk. But they are motivated enough to try.
Benefits of Self-Employment
Self-employed individuals enjoy many intangible benefits including independence and flexibility. However, when you work for yourself you do not get fringe benefits such as paid sick leave, disability insurance and health insurance — unless you purchase them out of your own pocket. You can deduct the cost of paying for health insurance premiums for you and your dependents.
Can You Be Employed and Self-Employed at the Same Time?
Yes. Many people are employees in jobs and also operate part-time or side businesses. If this describes you, your income is reported in two different ways for tax purposes.
- For employee income from a job, your employer will issue W-2 forms showing your earnings and withholding amounts. Your employer withholds income tax, Social Security and Medicare tax, and any benefit contributions.
- For self-employed income, you will have to track and report income yourself. You are also responsible for paying estimated quarterly taxes and self-employment tax (i.e., Social Security and Medicare tax).
Business Structures for the Self Employed
There are five common types of legal structures for self-employed business owners, and each has tax implications:
1. Sole Proprietorship: Most freelancers, gig workers and other self-employed are unincorporated sole proprietors and report income tax on their personal tax returns by attaching Schedule C showing net earnings from a trade or business.
2. Limited Liability Company: A self-employed person can form an LLC to limit liability. LLC income and expenses are typically reported on Schedule C.
3. C-corp or C-Corporation: A corporation is a separate entity subject to corporate tax rates.
4. Partnerships: Partners may include spouses who operate a business together, regardless of whether they have a formal partnership agreement.
5. S-corp: An S-corp is a tax election with the IRS. It enables you to treat earnings from a corporation or LLC as pass-through income on individual tax returns. Subchapter S provides owners with special tax advantages.
As self-employed individuals grow their business, they may choose to hire employees, contrasting with the nature of self-employment where individuals may opt not to hire staff.
Read more: Business Structure Tax Comparison.
Self-Employment Tax Filing Requirements
As a self-employed individual, you are required to file annual tax returns and pay quarterly estimated taxes. This involves filing a Schedule C (Form 1040) to report your business income and expenses, as well as a Schedule SE (Form 1040) to report your self-employment tax. Additionally, you may need to file other forms, such as Form 1099-MISC, to report income from clients.
Accurate record-keeping of your business income and expenses throughout the year is crucial. This not only simplifies the tax filing process but also ensures you can substantiate your deductions. Many self-employed individuals find it beneficial to hire a tax professional to navigate the complexities of tax filing.
Key tax filing requirements for self-employed individuals include:
- Filing a Schedule C (Form 1040) to report business income and expenses.
- Filing a Schedule SE (Form 1040) to report self-employment tax.
- Paying quarterly estimated taxes to avoid penalties.
- Keeping detailed records of business income and expenses.
- Filing additional forms, such as Form 1099-MISC, to report income from clients.
By staying on top of these requirements, you can avoid surprises and ensure compliance with tax laws.
Self-Employment Tax Filing Requirements
A self-employed person has several tax obligations, including the requirement to:
- File a Federal tax return each year reporting net earnings and pay all taxes due.
- Pay self-employment tax, which the IRS defines as Social Security and Medicare taxes, on net earnings. The self-employment tax rate is 15.3%, of which 12.4% goes toward Social Security and 2.9% toward Medicare taxes. A self-employed person must pay both the employer and employee portion of Social Security and Medicare taxes. You figure self-employment tax using Schedule SE.
- Pay estimated tax payments quarterly. Calculate estimated tax amounts carefully, as there are penalties for underpaying.
- File state and local tax returns, if applicable.
A self-employed individual often can write off business expenses as small business tax deductions. However, you must keep detailed records to substantiate expenses.
How Do the Self-Employed File Taxes?
To file their Federal taxes, sole proprietors and most LLCs will complete Form 1040, “Individual Tax Return. ” Include Schedule C “Profit or Loss From Business” to report expenses and net earnings from a trade or business. Also, Schedule SE is used to figure the self-employment tax to pay Social Security and Medicare taxes.
Partnerships must include Form 1065, “U.S. Return Of Partnership Income.”
Corporations file Form 1120, “U.S. Corporation Income Tax Return.” Taxpayers that have elected Subchapter S status must file Form 1120S, “U.S. Income Tax Return for an S Corporation.”
If you own a business that has employees, you must also submit IRS Form 940, “Employer’s Annual Federal Unemployment Tax Return.” Also, include IRS Form 941, “Employer’s Quarterly Federal Tax Return.”
Hobby vs Business?
For tax purposes, it’s important to distinguish between a self-employed business and a hobby (what the IRS calls a not-for-profit activity). If it is a hobby, you cannot use losses from it to offset income on your taxes. The IRS looks at several factors to determine if an activity is a business and not a hobby, including whether you:
- operate in a businesslike manner,
- depend on the income for your livelihood,
- make a profit in 3 out of 5 years.
See the full hobby vs. business test outlined in IRS Publication 535. 4
Financial Planning for Self-Employed Individuals
Financial planning is a critical aspect of self-employment. As a self-employed individual, you are responsible for your own financial security, including saving for retirement, paying taxes, and managing your business finances. Here are some essential tips:
- Set Aside Money for Taxes: Since you are responsible for paying your own taxes, including self-employment tax, it’s important to set aside money throughout the year. This helps you avoid a large tax bill at the end of the year.
- Save for Retirement: Without access to employer-sponsored retirement plans, consider setting up a SEP-IRA or solo 401(k) to save for retirement. These plans offer tax advantages and help you build a nest egg for the future.
- Manage Your Business Finances: Keep accurate records of your business income and expenses, and ensure you separate your personal and business finances. This makes it easier to track your financial health and prepare for tax season.
- Plan for Healthcare: As a self-employed individual, you are responsible for your own healthcare costs. Consider purchasing health insurance or setting up a health savings account (HSA) to manage these expenses.
By focusing on these key areas, you can create a solid financial foundation for your self-employment journey.
Managing Finances as a Self-Employed Individual
Managing finances as a self-employed individual can be challenging, but with the right strategies, you can stay on top of your financial game. Here are some tips:
- Keep Accurate Records: Maintain detailed records of your business income and expenses, as well as your personal finances. This helps you track your financial performance and simplifies tax preparation.
- Separate Personal and Business Finances: Avoid commingling funds by keeping your personal and business finances separate. This makes it easier to manage your money and ensures clarity in your financial records.
- Create a Budget: Develop a budget that includes both your personal and business expenses. This helps you plan your spending and ensures you have enough funds to cover your obligations.
- Prioritize Expenses: Prioritize your expenses, including taxes, retirement savings, and healthcare costs. This ensures you meet your financial responsibilities and avoid unnecessary debt.
- Consider Hiring a Financial Advisor: A financial advisor can provide valuable guidance on managing your finances and making smart financial decisions. They can help you create a financial plan tailored to your needs.
By implementing these strategies, you can effectively manage your finances and achieve financial stability.
Growing Your Self-Employment Business
Growing a self-employment business requires strategic planning and execution. Here are some tips to help you expand your business:
- Develop a Business Plan: A well-thought-out business plan outlines your goals, target market, and marketing strategy. It serves as a roadmap for your business growth and helps you stay focused on your objectives.
- Identify Your Niche: Focus on a specific niche where you can provide high-quality services to your clients. This helps you stand out in a competitive market and attract loyal customers.
- Build a Strong Online Presence: Establish a professional website and active social media profiles to showcase your services and connect with potential clients. A strong online presence enhances your visibility and credibility.
- Network: Networking with other business owners and potential clients can open up new opportunities and help you build valuable relationships. Attend industry events, join professional associations, and engage in online communities.
- Consider Hiring Employees: As your business grows, you may need additional help. Hiring employees can free up your time to focus on strategic activities and further expand your business.
By following these tips, you can effectively grow your self-employment business and achieve long-term success.
Common Challenges Faced by Self-Employed Individuals
Self-employment comes with its own set of challenges. Here are some common issues self-employed individuals face and how to address them:
- Managing Finances: Keeping track of your finances can be difficult, especially when it comes to taxes and retirement savings. Implementing good financial management practices and seeking professional advice can help.
- Finding Clients: Attracting clients can be challenging in a competitive market. Focus on building a strong online presence, networking, and providing exceptional service to retain and attract clients.
- Managing Time: Balancing multiple projects and responsibilities can be overwhelming. Use time management tools and techniques to stay organized and prioritize tasks.
- Dealing with Uncertainty: Income and expenses can be unpredictable. Build an emergency fund to cushion against financial fluctuations and plan for lean periods.
- Maintaining Work-Life Balance: Working from home can blur the lines between work and personal life. Set boundaries, create a dedicated workspace, and schedule regular breaks to maintain a healthy work-life balance.
By recognizing and addressing these challenges, you can navigate the complexities of self-employment and thrive in your business endeavors.
Is an Independent Contractor Self Employed?
If your business hires others to perform work, carefully assess whether to treat any such person as an independent contractor versus an employee. By definition an independent contractor is not an employee. But the individual must meet the IRS’s test to be considered an independent contractor. The test is based on the degree of control you have, the financial arrangements and the type of relationship.
If your worker meets the independent contractor test, that person must pay their own self-employment tax. For tax reporting purposes, you provide a Form 1099 instead of a W2 to independent contractors. You do not withhold social security or other taxes for independent contractors.
Do I Need to Register as Self Employed?
In the United States you do not need to register. However, you may need a license depending on your industry and location. For instance, many consumer-facing businesses such as food preparation or pest control require licenses or permits. Check with your municipality, county or state.
In conclusion, there’s a lot to consider to become self-employed. If you are someone frustrated with cubicle life, working for yourself may give you more autonomy. Remember, though, as a business owner you ultimately answer to customers or clients and must satisfy them.
Information Sources
Small Business Statistics
IRS. “Self-Employed Individuals Tax Center”
IRS. “Gig Economy Tax Center”
IRS. “Publication 535”
IRS. “Independent Contractor or Employee”
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