What Does It Mean to Be Self-Employed?
Someone might have asked you if you were "self-employed." Maybe you saw that term in a legal document or description of a federal or state law and 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?
A self-employed person is an individual who earns a living by working for themself, not as an employee of someone else and not as an owner (shareholder) of a corporation. But there are various definitions of "self-employed" that differ slightly.
IRS Definition. The IRS says that someone is self-employed if they meet one of these conditions:
- Someone who carries on a trade or business as a sole proprietor or independent contractor,
- A member of a partnership that carries on a trade or business, or
- Someone who is otherwise in business for themselves, including part-time business.
This definition would also include members (owners) of a limited liability company (LLC) because they are usually taxed as sole proprietors (single-member LLCs) or partners in a partnership (multiple-member LLCs).
Benefits for Self-Employed People. For the purpose of the CARES Act (2020) and the Families First Corona Response Act (2020), self-employed means an individual who "regularly carries on any trade or business," which is a broad definition. (Note that it doesn't say "full-time," so it could include part-time businesses.)
For example, the definition for the Paycheck Protection Program, in addition to the one above, includes a requirement that the person would be individuals who "operate under a sole proprietorship or as an independent contractor and eligible self-employed individuals."
Three Coronavirus Benefits for Self-Employed Individuals
The Paycheck Protection Program(PPP) is an SBA loan program for businesses that agree to keep or re-hire employees. This program is also available to self-employed persons. A new round of PPP loans is available for both new applicants and second-time applicants, beginning on January 11, 2021. New loan forgiveness options are now available.
The funds must be used mostly for payroll, but they can also be used for rent, mortgage interest, or utilities. You must apply through a bank or other lender.
Paid Sick Leave and Family Leave Tax Credits are available to self-employed individuals who can't work or who must care for family or a child for COVID-19 related reasons. The tax credits are calculated based on the number of days off work, up to 10 days, at a maximum per day. You can take the tax credit against your 2020 self-employment taxes, but if you need the money sooner, you can take them by reducing your quarterly estimated tax payments.
Read more about all of these benefits and other small business coronavirus relief options.
The details of this tax credit program are complicated, so check with your tax professional to make sure you are doing this correctly.
How to Defer Tax Payments from Tax Credits
As mentioned above, you can defer (delay paying) 50% of the Social Security part of your self-employment tax due, beginning March 27, 2020, through December 31, 2020. The deferral amount is based on your net earnings for the year.
Unemployment Tax Benefits During Coronavirus
The Pandemic Unemployment Assistance (PUA) program, part of the CARES Act (2020) extends unemployment benefits to self-employed individuals. If you are self-employed and you are otherwise able to and available to work and you have been affected by COVID-19 issues, you may be eligible for unemployment benefits. This unemployment assistance program ends on December 31, 2020.
Unemployment benefit programs are run by individual states, with the federal government giving them additional funds for this crisis. To find out more and apply, contact your state unemployment office. You may get unemployment benefits or a Paycheck Protection Program loan, but you can't receive both.
The definition of "self-employed" is different depending on the government agency and law. Some definitions are broader and some more precise. The definition for the purpose of a particular law or tax regulation governs eligibility in specific programs.
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. These business types are owned by self-employed business owners:
Sole proprietorship businesses have only one owner.
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 not considered self-employed in the same way as partners in a partnership.They do not have to pay self-employment tax on their hare of the corporation's income. S corporation owners receive a distributive share of the company's income, just as partners in a partnership. If the S corporation owner also works in the business as an employee, they are paid a salary for that work.
Being Self-Employed and Self-employment Taxes
Whatever you call yourself, if you are self-employed, an independent contractor, or a sole proprietor, a partner in a partnership, or an LLC member, you must pay self-employment taxes (Social Security and Medicare).
Self-employed individuals pay self-employment tax each year if their net earnings from self-employment are $400 or more. The tax is 15.3% (12.4% for Social Security and 2.9% for Medicare) on their annual net income from the business. Higher-income business owners pay an additional 2.9% on Medicare tax, but the Social Security portion is capped each year. The self-employment tax is calculated and added to the person's tax return as a liability.
Since you are not an employee, no Social Security/Medicare taxes are withheld from your wages. You may need to pay quarterly estimated taxes on self-employment tax and estimated income tax to avoid penalties.
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 pay self-employment taxes based on the net income from that business.
For partners in partnerships, members in multiple-member LLCs, and S corporation owners, the path to determining your income tax is a little more complicated. You must first prepare and file a tax return for the business and then a Schedule K-1, which shows your share of the income of the company.
Additional Tax Deduction for Self-Employed
The 2017 Tax Cuts and Jobs Act includes an additional tax deduction you may be able to take as a self-employed person. This Qualified Business Income deduction is a 20% deduction from net business income, in addition to regular business expense deductions. You may get this deduction if you file as a sole proprietor, partner, LLC owner, or S corporation owner, but not as the owner of a corporation. There are some limits and restrictions, so check with your tax professional or use business tax preparation software.
IRS. "Self-Employed individuals Tax Center." Who is Self-Employed? Accessed Apr. 8, 2020.
Small Business Administration. "Choose a Business Structure." Limited Liability Company (LLC). Accessed Apr. 8, 2020.
IRS. "Limited Liability Company (LLC)." Classifications. Accessed Apr. 8, 2020.
U.S. Congress. "Public Law 116-217. Families First Coronavirus Response Act." Sec. 7004. Page 217. Page "Accessed Apr. 8, 2020.
IRS. "COVID-19-Related Tax Credits for Required Paid Leave Provided by Small and Midsize Businesses FAQs." Accessed April 11, 2020.
IRS. "Deferral of Employment Tax Deposits and Payments Through December 31, 2020." Accessed May 19, 2020.
U.S. Department of Labor. "4 Things to Know About Unemployment Benefits Under the CARES Act." Accessed May 19, 2020.
IRS. "Instructions for Form 1120-S U.S. Income Tax Return for an S Corporation." Schedules K and K-1 (General Instructions. Purpose of Schedules. Page 21. Accessed Apr. 14, 2020.
IRS. "Self-Employment Tax (Social Security and Medicare Taxes)." Accessed Apr. 9, 2020.