Self-Employed Person Definition & Overview
Being self-employed has a lot of perks, like setting your own hours and doing work you love. However, it also comes with different tax requirements.
Self-employed individuals work for themselves instead of working for an employer. This article breaks down the definition of a self-employed person according to the IRS. We’ll also explain what this means for your taxes and go into the various pros and cons.
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- Self-employment is an attractive option for people who want to be their own boss.
- It allows you to earn an unlimited amount of income while doing something you love.
- It has its disadvantages as well. It’s more unpredictable than being a full-time employee, and you don’t receive employer-sponsored benefits. It also means that you’re responsible for calculating and paying self-employment taxes.
Who is a Self-Employed Person?
A self-employed person earns a living by working independently. They aren’t employees working for a company or another individual.
According to the IRS, you’re self-employed if you fall into one of the following categories.
- You carry on trade as an independent contractor or sole proprietor.
- You’re a member of a partnership that carries on a trade or business.
- You’re in business for yourself, including part-time.
You can be self-employed in a variety of different fields. Freelancers, artists, writers, lawyers, investors, insurance agents, and real estate agents are all typical roles for self-employed people. Having an Etsy store or selling products on Amazon would put you in the self-employment category, too.
Being self-employed is not related to the number of clients you have or the amount of money you make. Even if you’re a freelancer or gig worker who does all your work for a single client, you are still considered a self-employed person for tax purposes. Also, if you pursue an activity with the intention to make profit, the IRS will also consider you being self-employed.
Different Types of Self-Employment
There are several different forms of business structures for self-employment. These include:
One person owns the business and is fully responsible for any debts or legal issues. This structure gives a lot of flexibility in the way you want to run your business.
Limited Liability Company (LLC)
A LLC can have a single member. Unlike a sole proprietorship, LLCs have limited liability. They combine elements of corporations and partnerships.
This is similar to a sole proprietorship, but you perform contract work for another entity. However, you still decide when, how, and where to work on that project. Most freelancers fall under this category.
Member of a Partnership
If at least two people do business together and share any profits or losses, they form a partnership.
This structure is similar to self-employment, but S Corporation owners don’t pay self-employment tax on the employer share of the income they pay themselves as a salary. The remaining net income is taxable on the individual’s or partners’ income taxes – even if the money has not been distributed to them.
Benefits of Self-Employment
Self-employment means that you have the freedom to work on your own terms and do what you love. You set your hours, decide which clients to work with, and you can work from anywhere. In addition, working from home allows you to save money on transportation costs and wardrobe expenses.
Essentially, you are your own boss. That alone carries a sense of satisfaction that is not easily replaced.
Self-employed people can get certain tax deductions. This includes deducting expenses from setting up a home office and the other expenses that go along with working for themselves. For more information on the home office tax deduction, see the IRS document.
No Salary Limit
Since you don’t have a boss that sets your salary, there’s no employee compensation limit on how much you can earn. It’s up to you to decide how much you want to work and what rates to charge. This means you can potentially earn more money by doing more work.
Drawbacks to Self-Employment
While having no salary limit is a positive in some circumstances, it also means you don’t have a guaranteed salary or steady income. Self-employed people should always have enough savings to carry them through a low-earning period. Depending on your industry, you may see fluctuations in the amount of work available which results in a decrease in income.
Some expenses are tax-deductible, but working for yourself is likely to incur many business expenses that you have to pay for upfront. You can’t turn in an expense report to an employer and be reimbursed.
No Employee Benefits
Being self-employed makes you ineligible for employer-sponsored benefits. That means you have to purchase your own health insurance and fund your own retirement account. Finding a health benefit plan on your own can be costly depending on the benefit level you require to maintain good health.
How Do Taxes Work For Self-Employed People?
Self-employed people are treated differently than employees when it comes to paying taxes. The main difference is that self-employed people are responsible for paying their own taxes. 9 to 5 workers have their employers withhold Social Security and Medicare taxes automatically to meet their employment tax requirements.
If you’re self-employed, you must file annual income taxes as well as estimated quarterly self-employment taxes. The self-employment income tax goes toward Social Security and Medicare. This is similar to the FICA taxes withheld from the salary of most employees. You will also have to pay the employer part of the FICA taxes in addition to the employee part.
Any self-employed person who earns at least $400 in a year must pay a self-employment tax. The tax rate is 15.3%. This is broken down into 12.4% for Social Security on the first $147,000 earned and 2.9% for Medicare regardless of earnings. In comparison, an employee would only pay half of the amount – 7.65% – and the employer would cover the other half.
What Tax Deductions Can Self-Employed People Claim?
Self-employment makes you eligible for deducting various business expenses from your taxable income. According to the Tax Cuts and Jobs Act, the following expenses are deductible for self-employed people. Be sure to check with a tax professional to clarify any questions regarding expense deductions.
- Self-employment tax
- Home office
- Internet and phone bills
- Health insurance premiums
- Vehicle use
- Publications and subscriptions
- Business insurance
- Startup costs
- Retirement plan contribution
In addition, look into the Qualified Business Income (QBI) deduction. It allows certain businesses to deduct up to 20% of their business income.
A self-employed person doesn’t work for anyone but themselves. This allows for independence, scheduling flexibility, uncapped income, and plenty of other perks. The benefits are enticing. However, the lack of employer-backed insurance, automated tax withholding, and the cost of running a business are drawbacks that may deter some people from leaving the stability of working for a company.
FAQs About Self-Employed Person
Are business owners self-employed?
Self-employed persons can be business owners. For example, owners of sole proprietorships or LLCs are both a business owner and a business operator. Not all business owners are self-employed. “Owners” of corporations hire other people and may not be involved in daily operations.
What’s the minimum you must earn as a self-employed person to owe taxes?
If you make at least $400 in a year through self-employed work, you owe self-employment taxes. The taxes are paid for Social Security and Medicare.
How do you pay taxes if you’re in a partnership, multi-member LLC, or S Corp?
These situations have more complex tax requirements than sole proprietorships or single-member LLCs. First, file a tax return for the business. Then, file a Schedule K-1 to demonstrate your share of the company’s income. You might also be required to pay quarterly self-employment taxes.
What type of business structure should I choose as a self-employed person?
That entirely depends on the type of business activities you’re engaged in and how you want to approach your finances. For example, most freelancers are independent contractors or sole proprietorships already. But if you want to limit your legal and financial liability, you may wish to register an LLC.
When should you register as self-employed?
In the United States, there’s no employment registry and you’re not required to register as self-employed. You simply file your quarterly or annual tax returns and report your income that way.
Can a self-employed person have employees?
Yes, a self-employed person can hire employees.
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