Working for oneself rather than working for a specific employer who pays them a consistent salary
What is Self-Employment?
Self-employment refers to working for oneself rather than working for a specific employer who pays them a salary. Self-employed individuals often act as independent contractors by collaborating with other businesses.
Self-employment refers to working for oneself rather than working for a specific employer who pays them a salary. It is common in a variety of occupations, but one common theme is that self-employed individuals tend to be highly skilled in a specific area.
Some common types of self-employment include independent contractors, sole proprietorships, and partnerships.
Advantages of self-employment include being able to work with a high degree of freedom, independence, and control over business decisions. Still, downsides include a high degree of employment risk and a volatile income, as well as unlimited liability, and taking responsibility for all business losses.
How Does Self-Employment Work?
Self-employment is common in a variety of occupations, but one common theme is that self-employed individuals tend to be highly skilled in a specific area. Examples of occupations in which self-employment is common include various jobs within the skilled trades, writers, freelancers, artists, lawyers, accountants, financial services professionals, and investors.
Types of Self-Employment
The three types of self-employed individuals include:
1. Independent contractors
Independent contractors are individuals hired to perform specific jobs for clients, meaning that they are only paid for their jobs. Since they are not considered employees, they are not subject to workers’ compensation. Their clients, unlike traditional employers, do not need to withhold taxes from their payments for completed work.
Some examples of independent contractors include doctors, lawyers, journalists, accountants, and blue-collar occupations, such as plumbers, electricians, and handymen.
2. Sole proprietors
Sole proprietorships refer to a type of enterprise that is owned and operated by a single individual. However, it does not mean that a sole proprietor works individually; often, they may choose to hire a few employees to help them.
It should be noted that there is no legal distinction between the owner and the business entity in sole proprietorships, meaning that while the sole proprietor receives all the profits from the business, they face unlimited responsibility for all losses.
Partnerships are an arrangement between two or more individuals to manage and operate a business together and share in its profits and losses. It is somewhat similar to sole proprietorships, except that there is now more than one person with operational control.
There are different types of partnerships, ranging from general partnerships that enable all members to share profits and liabilities equally to other forms of partnerships where some partners might face limited liability. Sometimes, partners can also be “silent partners,” which means that a partner is not involved in the day-to-day operations of the business but contributes capital to the business instead.
Self-Employment vs. Entrepreneurship vs. Startup
It is also important to distinguish self-employment from other terms such as entrepreneurship and a startup. Entrepreneurship typically refers to the process of designing, launching, and operating a new business. It encompasses all new organizations, including small businesses that never intend to grow big and become registered, while a startup is a temporary new organization that is created with the intention to become larger beyond the founders and owners, and hire employees.
It should be noted that a self-employed individual is not the same as a business owner since the latter may hire employees to work for them and become the boss with responsibilities of supervising others while managing operations.
Business owners can also refer to owners who hold an ownership stake in the company but are not involved in the day-to-day operations, similar to a “silent partner” in some partnerships. However, self-employed individuals both own the business and are also the primary operator.
Self-Employment and Taxation
Self-employed individuals are considered to be running a business as an independent contractor, a sole proprietor, or a member of a partnership. In addition to income taxes, they need to pay Social Security and Medicare taxes in the form of a Self-Employment Contributions Act (SECA) tax. The self-employed individual pays both the employer and employee portion of the taxes since their clients do not withhold taxes.
Currently, the self-employment tax is 15.3% as of 2020, and 12.4% goes to Social Security on the first $137,000 of earnings, and 2.9% goes to Medicare tax.
Advantages of Self-Employment
One of the most notable advantages of self-employment is perhaps the large degree of freedom and flexibility involved. It allows the individual to do things that they love, set customized working hours, decide what work to do or not do, and often involves working from home, which saves a large amount of commuting time.
Self-employed individuals are able to become their own boss, enjoy unlimited amounts of creativity without fear of opposition from a manager, and exert complete control over most business decisions. Finally, with self-employment comes a sense of pride and achievement in creating a successful business and the power to make changes as one feels necessary.
When you are employed by a company you are considered an employee. Employees are on the company payroll, and the employer withholds federal and state taxes, Social Security, and Medicare.2
Employees are provided with unemployment and workers’ compensation insurance. Employees may be offered benefit packages that include things like paid sick leave, vacation, health insurance, or 401(k) or other retirement plan participation.
If you’re self-employed, you are responsible for paying your own taxes to the Internal Revenue Service (IRS) and to your state tax department.1 Even if you do not owe any income tax, you must complete Form 1040 and Schedule SE to pay self-employment Social Security tax.
In addition to income taxes, self-employed workers must also pay Social Security and Medicare taxes in the form of SECA (Self-Employment Contributions Act).
Unlike a typical employee, independent contractors work less regularly. They work as and when required, and usually bill by the hour or per project, depending on the terms of their contracts.
From a tax perspective, employing regular employees costs significantly more for employers than independent contractors because they are required to pay Social Security, Medicare, State, and unemployment taxes in addition to consistent, salary or wage-based work.3
Health Insurance and Other Benefits
However, self-employed individuals and independent contractors may be able to purchase health insurance and other benefits for you through the individual Health Insurance Marketplace or through organizations like the Chamber of Commerce or other groups that provide benefits for self-employed workers and small businesses.4
If you have self-employment income, you can take a deduction for health insurance expenses incurred for yourself, your spouse, and your dependents. Other self-employed tax deductions include home office costs, internet, phone, and fax expenses, meals, business travel and car expenses, interest on business loans, education, IRA contributions, and even some entertainment.5
Pros and Cons
While there are many positives to being self-employed such as choosing your own hours (full or part-time), shortening or completely avoiding your commute, focusing on career objectives that matter most to you, being able to work remotely and tax deductions, one of the downfalls is that benefits usually included in salaried work must be paid for out-of-pocket.
Furthermore, self-employed workers are responsible for both losses and profits. There are no paid holidays or sick pay, and the earning schedule may be less in the short term when you are starting out. With no boss or supervisor to manage you, it takes great focus and motivation to be self-employed. In many circumstances, hours are long and working on your own can be lonely.
Health insurance must be contracted for by the individual, there are no paid vacations or sick days, and retirement must be planned for.
The information contained in this article is not legal advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to the law.
Working for yourself
If you start working for yourself, you’re classed as a sole trader. This means you’re self-employed – even if you haven’t yet told HM Revenue and Customs (HMRC).
Running a business
You’re probably self-employed if you:
run your business for yourself and take responsibility for its success or failure
have several customers at the same time
can decide how, where and when you do your work
can hire other people at your own expense to help you or to do the work for you
provide the main items of equipment to do your work
are responsible for finishing any unsatisfactory work in your own time
charge an agreed fixed price for your work
sell goods or services to make a profit
Many of these also apply if you own a limited company but you’re not classed as self-employed by HMRC. Instead you’re both an owner and employee of your company.
You can be both employed and self-employed at the same time, for example if you work for an employer during the day and run your own business in the evenings.
You can check whether you’re self-employed:
Selling goods or services
You could be classed as a trader if you sell goods or services. If you’re trading, you’re self-employed.
You’re likely to be trading if you:
sell regularly to make a profit
make items to sell for profit
sell items on a regular basis, either online, at car boot sales or through classified adverts
earn commission from selling goods for other people
are paid for a service you provide
If you only occasionally sell items or rent out property (for example through auction websites or short-term rental apps), check if you need to tell HMRC about this income.
Contact HMRC for advice if you’re not sure whether you’re trading.
Registering as self-employed
If you’re self-employed, you may need to set up as a sole trader.
Other ways to work for yourself
There are other business structures apart from being a sole trader. For example, you can:
become a partner in a business partnership
set up your own limited company
Get help with your business
You can get help with setting up or growing your business, for example with funding your idea.
Popular jobs for self-employment
Here are some of the most common jobs for the self-employed: