What Does it Mean to be Self-Employed?
Are you thinking about making the leap into self-employment?
Who would give up a steady paycheck to go out on their own chasing gig after gig? The answer is more people today than in previous years, according to research. In a global 2017 ManpowerGroup study, Gig Responsibly: The Rise of NextGen Work, nearly all 9,500 workers polled, or 94%, reported being open to nontraditional ways of earning a living, including self-employment.
Last year, 57 million Americans worked for themselves in some capacity – a 3.7 million rise in the past five years. They put in about 1 million hours a week and contribute $1 trillion to the U.S. economy annually, according to the Freelancers Union, a national non-profit advocacy organization.
To be “self-employed” simply means working for one’s self, as opposed to be a full- or part-time, permanent employee for someone else. People who work for themselves have multiple, often interchangeable, titles, such as:
- Independent contractor
- Temporary worker
- Contingent worker
- Part-time worker
People who work for themselves while holding down a permanent job are known as “moonlighters,” or are said to have a “side hustle” in addition to their day job.
Out of the digital age came the terms “gig,” “on-demand” and “platform” to describe self-employed people who find much of their work through the Internet. In fact, the self-employment sector of the labor force has grown so fast and contributed so much to the U.S. coffers that they’ve become known as the “gig economy.”
Except for the need to be a self-starter, there’s no single profile of self-employed people that could accurately describe them all — they can be as diverse as a physician in private practice or an artist who sells paintings online. However, the ManpowerGroup study found that:
- Many of the self-employed are experienced
- 75% are the sole or major wage-earner in their household
- Knowledge and professional workers comprise 59% of the gig economy, while drivers for companies like Uber and Lyft and delivery personnel make up only 16%
The desire to be one’s own boss is often the default reason given for becoming self-employed, but a deep dive into why shows that a multitude of factors are in play.
In 2018, Harvard Business Review (HBR) reported on research that uncovered what drives people to go out on their own. Focusing on company consultants who became independent, the research found that:
- 25-35% say they freelance for some portion of their work income
- 90% actively chose to become independent consultants
- 10% went independent because of job loss
- When asked how long they planned to work as a consultant, 68% said for more than 3 years, up from 32% in a 2002 study
The independent consultants in the study said that they’re happier than they were as employees, their work is more rewarding, and their earnings are higher than their salaries were.
Of course, the downside of being self-employed is the “feast or famine” syndrome that deprives people of a steady, reliable income. Self-employment isn’t for people who need the security of a regular paycheck.
What the IRS says
Knowing what distinguishes one self-employed person from another is critical, because the Internal Revenue Service has its own regulations for people who work for themselves — and taxes them accordingly. For example, the agency distinguishes people who are in business for themselves from those who provide an occasional service on their own for a minimal amount of money.
Under IRS rules, a self-employed person:
- Carries out a trade or business as either a sole proprietor or an independent contractor
- Is a member of a partnership that operates a trade or business
- Is in business for one’s self, even if it’s a part-time business
- Must file an annual tax return and pay estimated tax quarterly
- Must pay self-employment tax (SE tax), which is a Social Security and Medicare tax, the same withholdings that come out of employees’ paychecks. (Note: The term “self-employment tax” refers only to Social Security and Medicare taxes and not income tax or other tax categories)
- Must file an income tax return for net earnings of $400 or more. Self-employed people whose net earnings fall below $400 must still file an income tax return if they meet other filing requirements. (See Form 1040 instructions (PDF)
- Must figure their business’s net profit or net loss to determine whether they’re subject to the SE and income tax, which they can do by subtracting their business expenses from their business income. (Note: If businesses expenses are less than business income, the difference is net profit, which is part of the income that must be reported. See Pub. 334, Tax Guide for Small Business (For Individuals Who Use Schedule C or C-EZ)
Employee or independent contractor?
Federal and state governments are clear about prohibiting employers from treating self-employed workers like employees. What’s less clear are the guidelines for distinguishing between the two classifications of workers.
To confound matters even more, the IRS, U.S. Department of Labor and U.S. Equal Employment Opportunity Commission each have a test to determine an independent worker’s status. Perhaps the most straightforward mechanism is California’s ABC test, which places the burden of making the correct workers classification on employers. Others states also use the ABC test.
Workers must meet all the following ABC test criteria to be considered independent. They must:
- Be free from the control and direction of the hiring entity
- Perform work outside the usual course of business for a company or outside its place of business
- Be engaged in another business, as well as the hiring entity
- Be in business for themselves.
For more on the 5th criteria, see Dynamex ABC test.
The growth of self-employment is changing the nature of work and testing the current labor laws’ relevancy.
More employers are turning to self-employed workers to perform the jobs that their employees don’t have the time or knowledge to do. Also, the self-employed are an available talent pool that allows employers to adjust staffing as the economy’s volatility dictates.
Even a bipartisan group of lawmakers in the U.S. Congress is looking at the rise in self-employed workers and considering changing outdated labor laws that neither protect their pay nor provide for their health and benefits needs.
According to a 2017 report by MBO Partners, a provider of services for the self-employed, independent workers will become 60% of the labor force by 2027. If the growth of self-employed workers stays on its course, the prediction will become a reality.