Log In Self-Employment: Definition, Benefits, and Types
Self-employment is a term used for jobs in which the worker is not an employee of another person or organization. Self-employed people work for themselves and are their own bosses. They may own their own businesses as sole proprietors, or work as independent contractors. Self-employment can be a great way to earn a living, but it also has its challenges.
In this article, we’ll discuss what self-employment means and an overview of how it works. We’ll also look at some of the pros and cons of being self-employed. Lastly, we’ll take a look at some of the most popular careers for self-employed workers.
Table of Contents
KEY TAKEAWAYS
- Self-employment means that an individual works for themselves rather than for a separate company or business entity.
- Self-employed individuals pay their own wages and are responsible for deducting their own taxes.
- Independent contractors, sole proprietorships, and partnerships are types of self-employment.
- Being self-employed offers flexibility, earning potential, and tax deductions.
- Some drawbacks include a lack of stability and up-front business expenses.
What Is Self-Employment?
Self-employment is being in business for yourself without being employed by an external company or entity. This means you are responsible for paying your wages and organizing your business.
There are several business structures in which someone qualifies as self-employed. These include working as a sole proprietor, being an independent contractor, being a member of a business partnership, and part-time self-employed structures like gig work. 1
A self-employed person is not tied to a company. This gives them greater flexibility for setting their own hours and dictating their work, but it also comes with additional obligations for tax estimation.
How Does Self-Employment Work?
Under self-employment, individuals operate as a business where they sell goods or services and use that revenue to pay their own wages. They are not bound to an external company or business entity.
Most self-employed persons have a specialized skill or practice, such as law, accounting, or freelancing. They can then contract these services out to other individuals or companies to generate revenue.
Self-employment requires individuals to file annual tax returns and pay quarterly estimated taxes. They must also pay additional taxes like Self Employment tax in place of the common Social Security and Medicare taxes that are normally deducted by employers.
Types of Self-Employment
There are several different types of self-employment structures:
Independent Contractor
An independent contractor is someone who is hired to perform a specific job for a company or an individual. They’re paid for that job or contract and do not receive additional benefits outside the scope of the contracted work.
Since independent contractors are not employees of their clients, the client doesn’t withhold any taxes from their payment.
There are many different occupations in which someone can work as an independent contractor. Some examples include plumbers, electricians, lawyers, photographers and accountants.
Sole Proprietorship
A sole proprietorship is a business structure in which the business owner and business are considered to be the same entity. This means that the business owner receives all the business profits but is also liable for any losses.
Sole proprietors are self-employed, but they can choose to hire other people to work with the sole proprietorship. Their business entity is then responsible for paying wages to those employees. The sole proprietor also pays their own wages.
Partnership
Partnerships are similar to sole proprietorships in that the business owners are responsible for all business profits and losses. The difference is that partnerships contain two or more business owners.
There are several different partnership structures ranging from full shared liability to limited liability where one party holds reduced liability. In a partnership, all business owners are considered to be self-employed.
Self-Employment Tax Considerations
Taxes for self-employed workers can be expensive and time-consuming. You should always consult a tax professional when filing annual taxes, but here are some important factors to keep in mind.
Self-Employment Tax
When you’re self-employed, you’re responsible for paying your own state and federal taxes. This includes both income taxes and a Self-Employment tax that combines Social Security and Medicare. Since you’re not employed by a company that automatically deducts these taxes from your payroll, it’s important to manage your own income and Self-Employment taxes. You can either pay these taxes quarterly or as part of your annual tax return.
Self-Employment Deductions
You may be able to deduct certain business expenses from your income. This can include things like rent or mortgage payments for the portion of your home used exclusively as a home office as well as business equipment and supplies. You can also deduct business travel expenses like plane tickets and vehicle fuel. There are also special startup tax deductions for expenses you’ve incurred while starting your business. Any deductions you claim as a self-employed individual must be for things used exclusively for business. For example, you can claim vehicle mileage for driving to and from a business meeting, but you cannot claim mileage for personal travel.
Self-Employment Health Insurance Deductions
You can also deduct the cost of health insurance premiums from your self-employment income for tax purposes. This includes both individual and family policies.
Self-Employment Retirement Contributions
You can also contribute to a retirement account like an IRA or SEP IRA. These are a deduction against the income you’ve received while running your business. This allows you to save for retirement on your own terms. It can also help ease your tax burden.
Self-Employment Benefits
One of the primary draws of self-employment is that it offers a great deal of flexibility. Self-employed individuals can choose when to work, what jobs they want to take, and how much they want to charge for their work.
Since self-employment allows individuals to set their own working hours, it also offers potentially higher earning opportunities. Income is directly tied to rates and hours worked, without the salary constraints set by a standard employer.
In addition to scheduling flexibility and job preferences, self-employment can provide a variety of tax deductions. Expenses associated with a home office, travel expenses, office supplies, and other necessities for running a business can be written off as deductions to lower your total taxable income.
Self-Employment Drawbacks
Self-employment also comes with a range of administrative challenges and income uncertainty. In addition to being good at their skilled labor, self-employed people must also be able to manage day-to-day business operations like invoicing clients, accepting payments, and sourcing new clients.
While not having a salary can offer more earning potential, it also means that self-employed people don’t have guaranteed income security. It’s important to save and budget for any potential slow periods.
Self-employment also means that individuals must pay their own up-front business expenses, which can require careful cash flow planning. They’ll also need to find their own health insurance and retirement plan since they don’t have access to employer-sponsored benefits. Self-employed people are responsible for paying income tax and a Self Employment tax that includes Social Security and Medicare tax, since they don’t have an employer to automatically deduct these taxes.
Conclusion
Self-employment allows individuals to manage their own businesses and control their own income without being tied to an outside business entity. This provides a great deal of freedom and flexibility, but also requires administrative skills and careful financial planning.
Accounting tools can help self-employed people create a robust business budget and manage their income and expenses. FreshBooks self employed accounting software makes it easy to organize contracts, invoice clients, and track expenses for self-employed tax deductions. Try FreshBooks free to streamline your self-employed financial management today.
Article Sources:
- Self-employed individuals tax center, IRS, https://www.irs.gov/businesses/small-businesses-self-employed/self-employed-individuals-tax-center
FAQs About Self-Employment
The IRS or Internal Revenue Service defines self-employment as “the conduct of a trade or business by an individual.” This includes anyone who is in business for themselves.
There is no one-size-fits-all answer to this question. Some of the most popular self-employed jobs include web development, writing, hair styling, massage therapy, and many more.
It depends on your state’s laws. In most cases, you will be able to collect unemployment if you’re self-employed. However, you may have to meet certain requirements.
Yes, you can make money being self-employed. However, it’s important to remember that it takes time and hard work to get your business up and running.
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