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 having 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 the jobs that they do. 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.
Disadvantages of Self-Employment
There are also disadvantages associated with self-employment though, such as the high uncertainty of employment and financial risk. While self-employed individuals are not limited in their salary, there is also the chance that one may not get a salary at all if the business is unprofitable. They also need to absorb all the losses and face unlimited liability, meaning that they need to shoulder all expenses themselves.
Financial downsides are also present, such as the need to pay the employer half of the self-employment tax for Social Security and Medicare. Health insurance common in employer-provided healthcare plans are unavailable, and self-employed individuals need to fund their own health insurance. In addition, self-employed individuals also do not receive the financial match that employers typically contribute to retirement plans.
CFI offers the Commercial Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below: