Self-Employment: Definition, Types, and Benefits

What Is Self-Employment?

A self-employed person does not work for a specific employer who pays them a consistent salary or wage. Self-employed individuals, or independent contractors, earn income by contracting with a trade or business directly.

In most cases, the payer will not withhold taxes, so this becomes the responsibility of the self-employed individual.

Self-employed persons may be involved in a variety of occupations but generally are highly skilled at a particular kind of work. Writers, tradespeople, freelancers, traders/investors, lawyers, salespeople, and insurance agents all may be self-employed persons.

Understanding Self-Employment

Although the precise definition of self-employment varies among the U.S. Bureau of Labor Statistics (BLS), the Internal Revenue Service (IRS), and private research firms, those who are self-employed include independent contractors, sole proprietors of businesses, and individuals engaged in partnerships.

A self-employed person refers to any person 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.

A self-employed person is not often the same thing as being a business owner. The owner of a business, for instance, may hire employees and essentially become the boss—an employee-owner who operates and manages the business.

Alternatively, 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 and is 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.

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. Because they are not considered employees, they do not receive benefits or workers’ compensation, their clients do not withhold taxes from their payments for work performed, and equal opportunity laws do not apply to them.

Examples of independent contractors include doctors, journalists, freelance workers, lawyers, actors, and accountants who are in business for themselves. It is worth noting that independent contractors are not just limited to specialized fields and can include a wide variety of jobs.

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 them with their work.

It is estimated that freelancers, particularly in what is known as the gig economy, will continue to grow. There were approximately $67.6 million freelancers in 2021, which is expected to grow to $86.5 million in 2027. By 2027, it is expected that 50.9% of the workforce will be freelancers.

Special Considerations

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 $142, 800 in 2021 and 2.9% goes to Medicare tax.

The self-employed person will pay the employer and the employee portion of Social Security and Medicare taxes. Those who make less than an annual net profit of $400 are exempt from paying taxes on that income.

The gig economy, a phenomenon that emerged with digitalization, includes everything from Uber drivers to dog walkers to consultants. There are upsides and downsides to being a gig worker.

The advantages are, of course, flexibility 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 sick leave or a healthcare plan. Gig workers must be disciplined when it comes to paying taxes because they do not receive W-2s and must handle all tax withholding independently.