Self employed

Self-employed refers to an individual who works for themselves rather than being an employee of an organization or company. This status means the individual directly earns income from their trade, business, or profession, assuming responsibility for their own operations, taxes, and benefits. It is a fundamental concept within personal finance and business structure, impacting how income is generated, reported, and managed. The self-employed can include sole proprietors, independent contractors, or members of a partnership.²⁹

History and Origin

Self-employment is not a modern phenomenon; it represents a return to an older economic model. For much of history, particularly before the Industrial Revolution, most workers were, by definition, self-employed, typically as farmers, artisans, or merchants. In the United States, for instance, approximately 50% of American workers were self-employed in 1900.²⁸ This proportion significantly declined through the 20th century, reaching a low of around 7% by 1977, as large corporations and traditional employment structures came to dominate the economic landscape.²⁷

However, the late 20th and early 21st centuries have seen a resurgence of self-employment, fueled by technological advancements, the rise of the [gig economy], and a shift towards more flexible work arrangements.²⁶,²⁵ This trend has led to an increasing number of individuals opting for or finding themselves in self-employed roles, with 11.9 million people identified as independent contractors in July 2023, representing 7.4% of total employment.²⁴ This renewed prominence underscores the dynamic nature of labor markets and individual financial pursuits.

Key Takeaways

• Self-employed individuals operate their own business or profession, earning income directly from clients or customers.
• Unlike traditional employees, the self-employed are responsible for paying both the employer and employee portions of Social Security and Medicare taxes, known as self-employment tax.²³,
• They typically pay estimated taxes quarterly to cover income tax and self-employment tax obligations.²²
• Self-employment offers flexibility and autonomy but often comes with less predictable income and the responsibility for securing one's own benefits like health insurance and retirement planning.
• The status of being self-employed has significant implications for income tax reporting and available tax deductions.²¹

Interpreting the Self-employed

Being self-employed fundamentally alters an individual's financial landscape compared to traditional employment. Income is not received as a consistent paycheck with taxes withheld; instead, the self-employed person receives gross payments from clients or customers. This requires proactive financial management, including setting aside funds for income tax and [Social Security] and [Medicare] contributions. For example, self-employed individuals are responsible for the entire 15.3% self-employment tax rate (12.4% for Social Security up to an annual limit and 2.9% for Medicare on all net earnings).²⁰

Understanding net income—gross income minus [business expenses]—is crucial for tax calculation and overall financial health. Thi¹⁹s status also necessitates careful [retirement planning] as employer-sponsored plans are not available. The self-employed must consider options like Solo 401(k)s or SEP IRAs.

Hypothetical Example

Sarah decides to leave her corporate job to become a full-time graphic designer. She is now self-employed. In her first quarter, she bills clients $15,000 for various design projects. This $15,000 is her [gross income]. She incurred $2,000 in [business expenses] for software subscriptions, marketing, and office supplies.

To calculate her net earnings for self-employment tax purposes, she subtracts her expenses from her gross income:

From this $13,000, she'll calculate her self-employment tax (typically on 92.35% of net earnings) and then determine her total [estimated taxes] (including income tax) to pay quarterly to the IRS. She'll also need to consider saving for future expenses and benefits, as she no longer has an employer to provide them.

Practical Applications

Self-employment has several practical applications across financial and economic spheres:

• Taxation: One of the most significant aspects of being self-employed is the altered tax responsibility. Self-employed individuals generally use IRS Schedule C (Profit or Loss from Business) to report their income and expenses and Schedule SE (Self-Employment Tax) to calculate their Social Security and Medicare taxes. The¹⁸y must pay estimated taxes throughout the year to cover their liabilities, as no employer withholds taxes for them. The¹⁷ IRS provides comprehensive guidance for small businesses and self-employed individuals regarding these obligations.
• ¹⁶ Business Structure: Self-employed individuals can operate under various [business structure]s, such as a [sole proprietorship], which is the simplest form, or more complex entities like a [Limited Liability Company (LLC)] or a [partnership], each offering different levels of liability protection and tax implications.
• Benefits and Insurance: Unlike traditional employees, the self-employed are responsible for securing their own [health insurance], disability insurance, and life insurance. They also fund their entire Social Security and Medicare contributions, rather than splitting them with an employer.
• ¹⁵ Economic Impact: The growth in self-employment, particularly in areas like the gig economy, reflects broader shifts in the labor market and contributes significantly to economic activity.

##¹⁴ Limitations and Criticisms

While self-employment offers considerable freedom and potential, it also comes with notable limitations and criticisms. A primary concern is the lack of traditional employee benefits such as employer-sponsored health insurance, paid time off, and contributions to [Social Security] and Medicare. The self-employed bear the full cost of these benefits, which can be substantial. Thi¹³s can lead to increased personal financial strain if not adequately planned for.

Another significant drawback is income volatility. Unlike a regular salary, [net income] for the self-employed can fluctuate significantly based on client demand, project availability, and market conditions, making financial planning and budgeting more challenging. Furthermore, the administrative burden of managing one's own taxes, including calculating and paying [estimated taxes] quarterly, and tracking all [business expenses], can be time-consuming and complex without proper systems or professional assistance.

Th¹²ere are also concerns about worker misclassification, where some individuals who should legally be considered employees are instead classified as [Independent Contractor]s, potentially denying them legal protections and benefits such as minimum wage and overtime pay. The¹¹ Department of Labor (DOL) has issued guidance to address this issue, emphasizing the "economic reality" of the relationship between a worker and a potential employer.

##¹⁰ Self-employed vs. Independent Contractor

While often used interchangeably, "self-employed" is a broader term, and "independent contractor" is a specific type of self-employed individual. All independent contractors are self-employed, but not all self-employed individuals are independent contractors.

⁷The key distinction often lies in the degree of control the client has over the worker and the worker's opportunity for profit or loss. An [Independent Contractor] typically offers services to the general public, works on a project-by-project basis, and controls the means and methods of their work, distinguishing them from an employee.

##⁶ FAQs

What are the main tax differences for someone who is self-employed?

The main tax difference is that self-employed individuals are responsible for paying their entire [Social Security] and Medicare taxes (the self-employment tax), which is 15.3% on their net earnings, unlike employees whose contributions are split with their employer. The⁵y also pay [estimated taxes] quarterly, rather than through payroll deductions, to cover their income tax liability.

##⁴# Do self-employed individuals get Social Security benefits?
Yes, self-employed individuals are eligible for Social Security and Medicare benefits, provided they pay self-employment taxes. These taxes contribute to their earnings record, which determines their eligibility for future benefits, including retirement, disability, and survivor benefits. The³ amount of benefits received is based on their average indexed monthly earnings over their highest 35 years of work.

##²# Can self-employed individuals deduct business expenses?
Yes, self-employed individuals can deduct ordinary and necessary [business expenses] directly related to their trade or business. The¹se deductions reduce their [net income], which in turn lowers their taxable income and the amount of self-employment tax owed. Common deductions include office supplies, professional development, and a portion of health insurance premiums.

How does being self-employed affect my ability to get a loan or mortgage?

Lenders often view self-employed income differently than traditional salaried income. They typically require a longer history of consistent income (often two years or more) and a thorough review of tax returns, such as Schedule C, to assess stability and profitability. While it can be more complex, being self-employed does not prevent individuals from obtaining loans or mortgages if they can demonstrate stable and sufficient [Adjusted Gross Income].