As business trends increasingly shift towards entrepreneurship, specialty trades, and the ‘gig economy’, many professionals are considering the jump into self-employment or small business ownership as an alternative to corporate jobs. What, if any, are the differences between being self-employed and becoming a small business owner? Which path should you choose to achieve your dreams while minimizing risk and maximizing independence and profit?
In this brief rundown, we’ll break down some of the central characteristics and differences of these options in terms of definition, legalities, and tax requirements, and some pros and cons of each. Here we go!
What’s the difference? Legally and practically speaking…
Self-employment means that you are the sole proprietor of the business, a member of a business partnership, or an independent contractor.
A sole proprietor is a one-person business without a legal entity like a corporation or partnership. You are the only owner of the business and are fully responsible for all financials, including any potential debt.
A partnership is similar to sole proprietors in that there is no legal entity separate from the individuals in the partnership, so each member is oftentimes considered a sole proprietor. They are responsible for all financials, and are not considered employees for tax purposes.
An independent contractor (IC) works for another person or business, but is not considered an employee. An IC can be registered as any type of business entity, but in practice, most are registered as sole proprietors. Regardless of how you are self-employed, the primary characteristic is that your business cannot expand beyond your own individual capacity.
Small business ownership is characterized by having others work for you. They can either be independent contractors or employees – and if they are the latter, you as the small business owner oversee their taxes. Many businesses may start off as self-employed, especially freelance and consulting types, and as business grows, they expand to become small business owners.
A limited liability company (LLC) is a common structure for small businesses because the members of the business cannot be personally held liable for company debts. It is a hybrid of a corporation (limited liability side) and a sole proprietorship (tax purposes). Most states even allow single-member LLCs. LLC ownership can be comprised of individuals in a business partnership, corporations, or other LLCs.
The advantage of opening an LLC is that owners report their share of losses and profits on their individual tax returns – bypassing corporate filing and double taxation. One of the most attractive aspects of the LLC is that, owners have limited liability for business debts and obligations.
Taxes for small business
Self-employed individuals are responsible for filing a self-employed tax return and paying quarterly estimated taxes. They must also pay self-employment tax, which is Social Security and Medicare tax usually withheld from employees’ paychecks. Income tax is paid in addition to the self-employment tax.
Self-employment tax is paid when your net profit (calculated by subtracting your business expenses from your business income) is greater than $400 annually. Throughout the year, you should file quarterly taxes to avoid penalties and a potentially large tax bill at year end. The IRS form 1040-ES helps to calculate the appropriate payments. At year end, use Schedule C to report your profit and loss. Taxes can be complicated and there are many deductions for being self-employed, contact your bookkeeper or accountant for more guidance.
In a self-employed partnership, taxes are paid by each member of the partnership based directly on his or her income or losses.
Taxes for business owners is somewhat more complicated, because for tax purposes there are different types of businesses, each with its own set of requirements. The chief benefits of LLC taxation, for example, are that taxes are paid through the personal returns of the owner or owners, and rates may be lower than the rates paid by corporations.
Insurance for small business owners and self-employed
According to the Small Business Administration, lawsuits can cost small businesses anywhere between $3,000 and $150,000. For unincorporated small business owners or contractors whose business gains and losses are ‘personal’ as described above, an insurance policy offering complete coverage and peace of mind is vital.
A competitive insurance policy for small business owners equals a broad umbrella to cover rainy day scenarios. Some insurance companies, such as Next Insurance, offer insurance policies custom fashioned to specifically address these potential liabilities for a variety of small businesses – available instantly and affordably online.
Hopefully this information on how to handle taxes for small businesses wasn’t too murky! But just in case, here are some down-to-earth pros and cons of self-employment vs small business that might be more easily digestible.
|Pros of being self-employed||Cons of being self-employed|
|Independence||If you stop working, you stop earning – no paid leave for holiday/sickness|
|Simplest to set up||Debts of the business are the debts of the owner|
|Work from home options||Responsibility for invoicing and collecting money|
|Flexible schedule||No minimum wage to fall back on|
|Self-employment tax deductions||No vacation or retirement plan benefits|
|Pros of being a small business owner||Cons of being a small business owner|
|Creating a business system ensures that company can continue to generate revenue even if the individual owner does not work for a period of time||More complex to set up and harder to run|
|The business is a separate entity from its owner, meaning different legal obligations regarding company debt||Despite the benefit of being personally dissociated from certain liability, there is still entrepreneurial risk involved|
|The ability to delegate tasks you otherwise would have to do if working alone||Responsible for employee payroll|