What Does It Mean to Be Self-Employed?

Who Is a Self-Employed Person?

A self-employed person is an independent contractor or a sole proprietor who reports self-employment income. Self-employed people work for themselves in various trades, professions, and occupations instead of working for an employer. Depending on the jurisdiction, self-employed persons may have special tax-filing requirements.

Key Takeaways

• A self-employed person earns their living from independent economic activity, rather than working for a company or an individual.
• Self-employed people may choose business structures like independent contractors, sole proprietorships, partnerships, corporations, S corporations, and limited liability companies (LLCs).
• Self-employed individuals are generally highly skilled in a specific kind of work.
• The self-employed have traded security for freedom.

How It Works for Self-Employed People

A self-employed person in the United States, as defined by the Internal Revenue Service (IRS), is someone who:

• Engages in a trade or business as a sole proprietor or an independent contractor
• Is a member of a partnership involved in a trade or business
• Is otherwise in business for themselves (including part-time endeavors)

In other words, a self-employed person earns income from an independent economic activity. It is contrasted with working for another individual or company, known as an employer. Even if a freelancer or an independent contractor works for only one client, they may still be self-employed.

Self-employed individuals may be involved in various occupations but are generally highly skilled in a specific kind of work. Writers, editors, tradespeople, traders/investors, lawyers, actors, salespeople, and insurance agents may all be self-employed.

Anyone who is self-employed but not an independent contractor may choose from various business structures. The most common options are partnership, sole proprietorship, corporation, S corporation, and limited liability company (LLC).

Advantages and Disadvantages of Self-Employment

Advantages

Perhaps the prime benefit of self-employment is freedom: the ability to do something you love, set your own hours, and choose your work. If you work from home, you can save money on transportation and work attire while getting a tax deduction for the business use of your home.

If you’re building your own business, you have complete control over how to do that, from whom to hire to how and to whom to sell your product. You are not limited by a salary and can earn as much money as you’re able to. Your problem-solving creativity won’t be hindered by a boss with limited vision. Finally, there is a sense of pride and accomplishment in creating a successful enterprise that is solely yours.

Disadvantages

The biggest disadvantage of self-employment is the risk and uncertainty. While you’re not limited in earning potential, you’re also not guaranteed a specific salary. During slow months, you have to be prepared to handle financial losses. All business expenses must be covered by yourself, without the ability to submit expense reports for reimbursement. If you work alone, you miss out on the camaraderie and support of coworkers.

There are also financial downsides. You must pay Social Security and Medicare taxes in full, without the benefit of employer contributions. You’re responsible for funding your own health insurance and retirement savings plans. Additionally, you must make quarterly estimated tax payments to the IRS.

Fortunately, there are retirement savings options available, such as the solo 401(k), the simplified employee pension individual retirement account (SEP IRA), and the savings incentive match plan for employees (SIMPLE) IRA, but you must fund them independently.

These plans usually have higher contribution limits compared to employer-sponsored 401(k) plans. For example, the limit for a SEP IRA in 2023 is either 25% of compensation or $66,000 (rising to $69,000 in 2024), while the limit for a 401(k) is $22,500 in 2023 (rising to $23,000 in 2024). However, you need to earn enough to take advantage of the higher limit.

How Self-Employed Persons Pay Taxes

A self-employed person must file annual taxes and pay estimated quarterly taxes. In addition to income tax, they generally have to pay a 15.3% self-employment tax, which covers Social Security (12.4% on the first $160,200 in 2023, rising to $168,600 in 2024) and Medicare (2.9% with no ceiling).

A self-employed person can deduct the employer-equivalent portion of the tax to lower their adjusted gross income (AGI). To determine if they owe self-employment tax, an individual must calculate their net income and loss from their activities using Schedule C. Anyone who earns at least $400 must pay the tax.

Self-employed individuals may also be eligible to deduct expenses for the business use of their home, referred to as the "home office deduction." This can include insurance, rent, repairs, security systems, utilities, and service bills used for business purposes, subject to specific IRS rules.

Self-Employed Persons: Europe

In the United Kingdom, individuals who work for themselves are classified as "sole traders." Several factors determine whether a person is considered self-employed, including being responsible for the success and failure of their own business, having multiple customers, deciding their own working arrangements, and more.

In the European Union, self-employed persons are defined as those who work in their own business, professional practice, or farm for the purpose of earning a profit and do not employ other persons.

How Much of My Income Can Be Taxed for Social Security?

Social Security tax applies to incomes up to $160,200 in 2023, rising to $168,600 in 2024. The self-employed tax rate is 12.4%. Income above these limits is not subject to Social Security tax.

Who Is Considered Self-Employed?

According to the IRS, you are considered self-employed if you engage in a trade or business as a sole proprietor or an independent contractor, are a member of a partnership involved in a trade or business, or are in business for yourself (including part-time endeavors).

How Much Is the Self-Employment Tax?

The self-employment tax is 15.3%, consisting of 12.4% for Social Security and 2.9% for Medicare.

The self-employment tax is 15.3%, consisting of 12.4% for Social Security and 2.9% for Medicare.