What does it mean to be independent?

Have you ever been asked if you are “self-employed”? You may have seen this term in a legal document or description of federal or state law and are not sure what it means and whether it applies to you. To be self-employed, you need to work for yourself and not be an employee or shareholder in another company.

What does “self-employed” mean?

Self-employed individuals earn their livelihood by working for themselves and are not employees of someone else or owners (shareholders) in a company. However, there are slightly different definitions of “self-employment.”

IRS Definition of “Self-Employment”

The IRS states that you are considered self-employed if you meet any of the following conditions:

  • You operate a trade or business as a sole proprietor or independent contractor.
  • You are a member of a partnership that operates a trade or business.
  • You work for yourself, including part-time businesses.

This definition also includes members (owners) of limited liability companies (LLCs) since they are typically taxed as sole proprietors (single-member LLCs) or partners in a partnership (multi-member LLCs).

Types of Businesses Owned by Self-Employed Individuals

Being self-employed means that you are managing your own business, but this business can be established in various ways. Here are the types of businesses that self-employed individuals can own:

  • Sole proprietorship: businesses owned by only one person.
  • Partners in a partnership: share in the ownership of the business, manage the business, and share in its profits and losses.
  • Owners (members) of limited liability companies (LLCs): the owner of a single-member LLC manages the business in the same way that a sole proprietor does, but with liability protection. The owners of a multi-member LLC manage their business in the same way as partners in a partnership.
  • S Corporation owners: are not considered self-employed in the same way that partners in a partnership are. They do not have to pay self-employment tax on their share of corporate income. S Corporation owners receive a distributed share of the company’s income, just like partners in a partnership. If an S Corporation owner also works for the business as an employee, they will be paid a salary for that work.

Self-Employment Taxes

Regardless of what you call yourself, if you are self-employed, an independent contractor, a sole proprietor, a partner in a partnership, or a member of a limited liability company (LLC), 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) of the annual net income from self-employment.

High-earning business owners pay an additional 0.9% tax on the Medicare tax, but the Social Security portion is capped annually. Self-employment tax is calculated and added to the individual’s tax return as a liability.

Note: Self-employed individuals are not employees, so no Social Security or Medicare taxes are withheld from their wages. They may need to pay estimated quarterly 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 (pass-through taxes). If you are a sole proprietor (or a member of a single-member LLC), you must complete Schedule C and pay self-employment tax based on the net income from that business.

For partners in partnerships and members of multi-member LLCs and S Corporation owners, the path to determining your income tax is a bit more complicated. You must first prepare and file a business tax return and then Schedule K-1, which shows your share of the company’s income.

Benefits

Additional Tax for Self-Employed Individuals

The Tax Cuts and Jobs Act of 2017 includes an additional tax benefit that you may be able to take advantage of as a self-employed individual. This deduction for qualified business income is a 20% deduction of your net business income, plus the usual business expense deductions. You may qualify for this deduction if you file as an individual, a partner, an LLC owner, or an S corporation owner, but not as a C corporation owner.

There are some limitations and restrictions, so check with your tax professional or use business tax preparation software.

Unemployment for Self-Employed Individuals

The Pandemic Unemployment Assistance (PUA) program, part of the CARES Act, extended unemployment benefits to self-employed individuals until September 2021, but this was a special case due to the pandemic.

Generally, if you are self-employed and did not pay unemployment insurance through your salary, you are likely not eligible for unemployment benefits. If you are unsure, check with your state’s labor department or unemployment insurance division.

Frequently Asked Questions (FAQs)

How do you prove your income as a self-employed individual? When asked to prove income as a self-employed individual, you can use your tax return, accounting records, copies of business bank statements, contracts or work agreements, receipts for invoices or allowances, and more.

What is the tax rate for self-employed individuals? If you are self-employed, your tax rate will depend on the amount of income you earn during the tax year. You are also responsible for paying self-employment taxes, and the rate for this tax is 15.3%, consisting of 12.4% for Social Security and 2.9% for Medicare.

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Sources:

IRS. “Self-Employed Individuals Tax Center.”

Small Business Administration. “Choose a Business Structure.”

IRS. “Limited Liability Company (LLC).”

IRS. “About Form 1120-S U.S. Income Tax Return for an S Corporation.”

IRS. “Self-Employment Tax (Social Security and Medicare Taxes).”

IRS. “Questions and Answers for the Additional Medicare Tax.”

IRS. “About Form 1065, U.S. Return of Partnership Income.”

IRS. “Qualified Business Income Deduction.”

New York State Department of Labor. “Benefit Extension Information.”

New Jersey Division of Unemployment Insurance. “Who Is Eligible for Benefits?”

New York State Department of Taxation and Finance. “Checklist for Self-Employed Individuals.”

IRS. “Self-Employment Tax (Social Security and Medicare Taxes).”

Source: https://www.thebalancemoney.com/what-does-it-mean-to-be-self-employed-398471

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