Who Is a Self-Employed Person?
A self-employed person is an independent contractor or a sole proprietor who reports self-employment income. Self-employed people work for themselves at a variety of trades, professions, and occupations rather than working for an employer. Depending on the jurisdiction, self-employed persons may have special tax-filing requirements.
- A self-employed person is someone who earns their living from any independent pursuit of economic activity, rather than working for a company or an individual.
- The business structures that self-employed people may choose include independent contractors, sole proprietorships, partnerships, corporations, S corporations, and limited liability companies (LLCs).
- Self-employed individuals are generally highly skilled at a particular kind of work.
- The self-employed have traded the comforts of security for the exhilaration of freedom.
How It Works for Self-Employed Persons
A self-employed person in the United States, as defined by the Internal Revenue Service (IRS), is one who:
- Engages in a trade or business as a sole proprietor or an independent contractor
- Is a member of a partnership involved in a trade or business
- Is otherwise in business for themselves (including a part-time endeavor)
In other words, a self-employed person is anyone who earns their living from any independent pursuit of economic activity as opposed to earning a living working for a company or another individual (an employer). A freelancer or an independent contractor who performs all of their work for a single client may still be a self-employed person.
Self-employed individuals may be involved in a variety of occupations but generally are highly skilled at a particular kind of work. Writers, editors, tradespeople, traders/investors, lawyers, actors, salespeople, and insurance agents may all be self-employed.
Anyone who is self-employed but not an independent contractor may choose a variety of business structures. The most common are partnership, sole proprietorship, corporation, S corporation, and limited liability company (LLC).
Benefits of Self-Employment
Perhaps the prime benefit of self-employment is freedom: to do something that you love, to set your own hours, to decide which work you will and will not do. If you work from home, you can save money on transportation to the office, as well as on the wardrobe that office requires, and get a tax deduction for the business use of your home (more on that below).
If you are building your own business, you have complete control over how to do that, from whom (if anyone) to hire to how and to whom to sell your product. You are not limited by a salary as to how much money you can earn. Your creativity at solving problems will not be stymied by a boss with limited vision. Finally, there is the sense of pride and accomplishment in creating a successful enterprise that is your domain and yours alone.
Disadvantages of Self-Employment
The biggest disadvantage of self-employment is the uncertainty of risk. You may not be limited in what you can earn, but you are also not guaranteed a certain salary. When you have a bad month or two, you have to be able to absorb the losses. You must shoulder all business expenses yourself; there is no turning in an expense report for reimbursement. If you pursue your business by yourself, you forfeit the camaraderie and support of coworkers.
There are also financial downsides. You must pay the employer half of Social Security and Medicare taxes in addition to paying your half. You are not eligible for employer-provided healthcare plans and must instead fund your own health insurance. You have no access to employer-sponsored retirement savings plans, such as a 401(k), and you can’t receive the financial match that an employer frequently contributes to such retirement plans.
There are alternative retirement savings plans available to you, such as the solo 401(k), the simplified employee pension individual retirement account (SEP IRA), and the savings incentive match plan for employees (SIMPLE) IRA, but you must fund them all by yourself. Fortunately, the contribution limits for these plans are usually higher than 401(k) plans. With a SEP IRA, for example, in 2020 the limit is either 25% of compensation or $57,000, while the 2020 limit for a 401(k) is $19,500. Of course, you have to actually make the money to take advantage of the higher limit.
Because taxes are not deducted from their paychecks, self-employed persons must pay estimated taxes in advance to the IRS on a quarterly basis.
How Self-Employed Persons Pay Taxes
A self-employed person has to file annual taxes and pay estimated quarterly tax. On top of income tax, they also must generally pay a self-employment tax, which is a Social Security and Medicare tax for the self-employed that was 15.3% as of 2020 (12.4% for Social Security on the first $137,700; 2.9% for Medicare with no ceiling). A self-employed person can deduct the employer-equivalent portion of the tax to lower their adjusted gross income (AGI). For an individual to figure out if they owe self-employment tax, they must determine their net income and loss from their activities on Schedule C. Anyone who has earned at least $400 must pay the tax.
The self-employed may be eligible to deduct expenses for the business use of their home, known as the “home office deduction.” Under specific IRS rules, you may be able to deduct such things as the portion of your insurance, rent, repairs, security systems, and utilities and services bills that was used for business purposes.
Self-Employed Persons: Europe
Individuals who work for themselves in the United Kingdom are classified as “sole traders.” If a person runs their own business and is responsible for its success and failure, has several customers simultaneously, decides when and how to work, and has a number of other characteristics, then they are likely self-employed.
In the European Union, self-employed persons are defined as those “who work in their own business, professional practice or farm for the purpose of earning a profit, and who employ no other persons.”