What Does it Mean to Be Self-Employed?

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Someone might have asked you if you were "self-employed." Maybe you're not sure what that term means and whether it applies to you. Let's take a look at what it means to be "self-employed.

What Does "Self-Employed" Mean? 

Someone who is self-employed is the owner of a business, an individual who earns a living by working for himself/herself, not as an employee of someone else and not as an owner (shareholder) of a corporation.

You are self-employed if you are an independent contractor, meaning that you are an independent business person, responsible for running your own trade or business. You are also self-employed if you call yourself a freelancer, someone who does work for different businesses or individuals. If you have an online business, you are considered self-employed.

You could look at a self-employed individual as the opposite of: 

  • Being an employee: An employee works for an employer for wages or salary. 
  • Being a corporate shareholder: A shareholder gets income from the corporation from dividends, taxed differently from wages. Corporate owners may also work in the corporation as employees, not as self-employed.

Types of Businesses Owners Who are Self-Employed

Being self-employed means running your own business, but that business can be set up in a variety of ways.

The IRS says that a self-employed individual is someone who "owns an unincorporated business," like a sole proprietor or independent contractor or a sole owner of an LLC. In addition, the IRS says someone who owns a partnership or a multiple-owner LLC also has earnings from self-employment.

We'll use the IRS definition of self-employment for this article because it includes any business owner who (a) pays income tax through a personal tax return and who (b) must pay self-employment taxes.

So, these business types are owned by self-employed business owners:

Sole proprietorships, businesses that have only one owner. A freelancer or independent contractor is probably a sole proprietor.

Partners in a partnership share in the ownership of a business. They manage the business and share in the profits and losses.

Owners (members) of limited liability companies (LLCs) are also self-employed. The owner of a one-owner LLC runs the business in the same way as a sole proprietor, but with liability protection. The owners of a multiple-owner LLC run their business in the same way as partners in a partnership.

S corporation owners are considered self-employed in the same way as partners in a partnership. S corporation owners receive a distributive share of the company's income, just as partners in a partnership. If the S corporation owner works in the business, they are paid a salary and must pay FICA taxes.

Being Self-employed and Self-employment Taxes

An individual who is self-employed must pay self-employment taxes (Social Security and Medicare). The IRS considers you to be self-employed for self-employment tax purposes if you receive a 1099-MISC form as a non-employee. 

Self-employed business owners pay self-employment tax at the rate of 15.3 percent 12.4 percent for social security and 2.9 percent for Medicare) on their annual income from the business. Higher-income business owners pay an additional 2.9 percent on Medicare tax, but the social security portion is capped each year.

Because self-employed individuals don't have an employer, they pay the entire amount of self-employment tax each year. But the tax is based on the profits of the company, so if there is no profit, there's no self-employment tax.

​How Do Self-Employed Individuals Pay Income Taxes?

If you are self-employed, you pay income taxes on your personal tax return (called "pass-through taxes"). If you are a sole proprietor (or single-member LLC) you must complete a Schedule C and you pay self-employment taxes based on the net income from that business. 

For partners in partnerships and members in multiple-member LLCs, the path to determining your income tax is a little more complicated, since you first must prepare a partnership tax return (for LLCs also) and then a Schedule K-1, which shows your share of the income of the company.

A self-employed individual must also pay self-employment taxes on the profits of the business each year. Losses from self-employment may be used to offset income to the individual from other sources.

New Tax Law and Self-Employment

The 2017 Tax Cuts and Jobs Act has made some changes to the way self-employed individuals are taxed. Some self-employed business owners may benefit from the regulations in this law, by being able to take a 20 percent deduction from net business income, in addition to regular expense deductions. This new provision, called a Qualified Business Income is complicated and there are limits and exclusions. Check with your tax professional before you attempt this deduction.