What Is Self-employment?
A self-employed individual works for themselves rather than for a specific employer who pays them a consistent salary or wage. A self-employed individual, or an independent contractor, earns income by contracting with a trade or business directly. Someone who is self-employed will receive payment with no tax withholding in many cases; thus, they are responsible for paying their taxes correctly.
Although the precise definition of self-employed varies among the U.S. Bureau of Labor Statistics, the Internal Revenue Service and private research firms, those who are self-employed include independent contractors, sole proprietors of businesses, and individuals engaged in partnerships.
Self-Employed vs. Business Owner
Self-employment is not the same as business ownership. For example, a business owner has an ownership stake but may not be involved in the day-to-day operations of the company. In contrast, a person who is self-employed both owns the business, but they are also the primary or sole operator. The taxation rules that apply to those who are self-employed differ from the employee or a business owner.
- Those who are self-employed work for themselves and contract directly with clients.
- The self-employed do not receive any employee benefits such as health plans.
- The self-employed are not subject to tax withholding and are responsible for paying their own taxes.
Types of Self-employment
Independent contractors are businesses or individuals hired to do specific jobs. They receive payment only for the jobs that they do and, because they are not considered employees, they do not receive benefits or worker's compensation. Additionally, equal opportunity laws do not apply to them, and their clients do not withhold taxes from their payments for work performed. Examples of independent contractors include doctors, journalists, lawyers, and accountants who are in business for themselves. It is worth noting that Independent contractors are not just limited to specialized fields. An NPR/Marist poll for 2018, found that one in five jobs in the United States is a contracted worker as opposed to a full-time employee.
Sole proprietors are the only owners of unincorporated businesses while partnerships involve two or more self-employed people who form a business together. Independent contractors, sole proprietors, and partnerships often hire a small number of employees to help with their work.
As of 2016 (the most recent figures as of early 2019), self-employed people and their employees accounted for approximately 30% of the workforce in the United States. The industries with the highest rates of self-employed people include agriculture, construction, and business and professional services.
Taxes for the Self-employed
A self-employed person must file annual taxes and pay estimated quarterly tax. On top of income tax, they are also typically required to pay a self-employment tax of 15.3%. Of this tax, 12.4% goes to Social Security on the first $132,900 of earnings, and 2.9% goes to Medicare tax. Those who make less than an annual net profit of $400 are exempt from paying taxes on that income. (For more, see Self-Employment Tax (Social Security and Medicare Taxes)
Real World Example
The gig economy, a phenomenon that emerged with digitalization, includes Uber drivers to dog walkers to consultants. The advantages of being a gig worker are, of course, flexiblity and control, but the disadvantages are that there is no guarantee of work, the pay is often low, and there are no employee benefits such as a healthcare plan, according to Richard Eisenberg, a contributor to Forbes. Gig workers must be disciplined when it comes to paying taxes becauses they do not receive W-2s and are not subject to tax withholding.