You’ve seen the term “self-employed,” but exactly what does self-employed mean? It’s a term that has to do with how you work and the way you pay your taxes, and we’re going to break down all of that and more.
- Self-employed people work for themselves and contract out their services to businesses and/or individuals.
- Being self-employed means you’re responsible for self-employment taxes, and you may qualify for certain deductions.
- If you’re self-employed, you might be an independent contractor, sole proprietor, LLC, or in a partnership.
- The main advantage of self-employment is flexibility, while the biggest disadvantage is an unpredictable income.
What Does Self-Employed Mean?
Being self-employed means you work for yourself and contract out your services directly to your clients. Overall, self-employment is a flexible and rewarding way to work, but there are trade offs, like income volatility and employment risk.
According to the Merriam-Webster Dictionary, self-employed means “earning income directly from one’s own business, trade, or profession rather than as a specified salary or wages from an employer. And the first use of the word was in 1916.
IRS Definition of Self-Employed
The biggest implications for self-employed people have to do with paying taxes, so it’s important to understand that the IRS defines self-employed as:
- Carrying on a trade or business as a sole proprietor or independent contractor.
- Member of a partnership between two or more people who do a trade or business where each person contributes money, property, labor or skill, and shares the profits and losses of their business.
- Being in business for yourself, including gig work, side hustles and part-time business, such as food delivery driving or walking dogs.
If you’re a member of a limited liability company (LLC), you’re included in the above IRS definition of self-employed because you’re usually taxed as sole proprietor or as a partner in a partnership.
Related: Best Self-Employed Retirement Plans
Types of Self-Employment
There’s a variety of work that falls under the self-employment category, from freelancers, lawyers, artists, food delivery drivers, solo-preneurs, and more. To help you understand more about the possibilities, let’s look at the different types of self-employment:
- Independent contractor: This is a type of tax designation in the self-employment space that applies to people who contract out their services to other businesses and/or individuals. All independent contractors are self-employed, but not all self-employed people are independent contractors. Examples include food delivery drivers, electricians, doctors, and freelance writers and bookkeepers.
- Sole proprietorship: This is a type of business that’s owned and operated by a single person, but it doesn’t always mean that the sole proprietor works on their own — many hire a few employees. Sole proprietors receive all the profits from their business, but they also assume all of the financial risks.
- Limited liability companies (LLC): This is almost the same as a sole proprietorship, except the LLC designation offers liability protection to the business owner. There can be single and multiple-owner LLCs, and all are considered self-employed.
- Partnership: This is an arrangement between two or more individuals who share ownership of their business, manage it together, and share the profits and losses.
Related: LLC vs. S-Corp: What’s The Difference?
Advantages and Disadvantages of Self-Employment
There are a lot of people who dream of self-employment because they want to be their own boss, but self-employment isn’t for everyone. So let’s take a look at the pros and cons of self-employment.
Advantages of Being Self-Employed
- More flexible schedule: Being self-employed means you can choose when you work. As long as you’re completing the work your clients expect, you can work any hour of the day, take time off, etc.
- You’re in control: Determining your own schedule, where you work, the clients you work with, how you grow your business, etc. You’re the boss and in charge of your business.
- More passionate about what you’re doing: Starting a business based on something you’re passionate about is truly one of the most incredible things about self-employment.
- Scale when you want: When you’re ready to grow your business, you can outsource, grow your skill set and offerings, etc.
- Ways to save on expenses: Self-employed people can claim certain expenses and deduct them at tax time.
- Financial rewards: Your earnings are determined by your actions, and you see and feel those rewards on a personal level.
Disadvantages of Being Self-Employed
- Unpredictable income: If you lose a client, have a slow month, or if a client doesn’t pay, your income can take an unexpected hit.
- Work-life balance is difficult: Because you’re running your own business, it gets difficult to separate work from your personal life, resulting in long days and feeling like you’re always on.
- Lack of structure: Some people thrive in unstructured environments, but that’s not the case for everyone.
- No employee benefits: Health insurance, paid time off, retirement, etc. — none of those are a given.
- More responsibility and pressure: There are daily pressures and stresses that come along with being self-employed.
Understanding Self-Employment Taxes
To understand what self-employment means, you have to grasp the tax implications laid out by the IRS. Below you can find answers to some of the most common questions:
How do self-employed individuals pay income taxes?
Generally, self-employed people file an annual tax return and pay estimated tax quarterly. You’re essentially pre paying your taxes in four big chunks rather than as one big payment.
You’ll need to pay estimated quarterly taxes if you expect to owe tax of $1,000 or more when your return is filed, and this is easier if you set money aside from each paycheck.
How much is self-employment tax?
The self-employment tax rate is 15.3% and is made up of two parts: 12.4% for social security and 2.9% for Medicare.
Are there tax deductions for self-employed people?
Yes! Self-employed people can claim 50% of what they pay in self-employment tax as an income tax deduction, and you can also deduct expenses you accrue over the year. Your expenses might include internet, office space, cell phone, vehicle, supplies, and so on.
Is there unemployment for self-employed people?
Typically, no, and that’s because most self-employed people do not pay into their state’s unemployment fund, therefore not qualifying for benefits. However, if you were hired as an independent contractor, you may be eligible for benefits depending on the law in your state. Because eligibility varies state by state, you should check with your state unemployment office to learn more.
You can read more about taxes in our Guide to Side Hustle Taxes.
What Does Self-Employment Mean? The Final Word
Self-employment means you work for yourself and contract out your services to your clients. Because of the flexibility and income potential, it’s a dream for many people, but the reality is that it’s still a job. As long as you’re willing to learn and hustle, it can be one of the best things you’ve ever done for yourself. And if you’re ready to make the leap, check out Best Self Employed Jobs You Can Start in 2023.
Because self-employed means you’re working for yourself and contracting out your services to others, there are a lot of different options for work, and here are some examples:
- Freelancer, like writer, graphic designer, virtual assistant, bookkeeper, or web developer
- Food delivery driver
- Plumber, electrician,
- Certified financial planner
Self-employed people aren’t always business owners. For example, a DoorDash driver is technically self-employed, but they don’t own their business.