You may not notice any difference between the type of work an employee and a self-employed contractor performs. However, for tax purposes, being classified as self-employed will shift to you a lot of the tax responsibilities that employers assume for their employees. Moreover, if you are an entrepreneur, the question of whether or not you fall under the self-employed tax classification depends on how the business is structured.
Employee and Contractor Differences
The Internal Revenue Service uses several factors to assess whether a worker is an employee or a self-employed independent contractor. These factors include whether the worker or the company determines which tasks are done and how the work is performed, whether the worker risks incurring losses and which party supplies workspace and the equipment needed to perform the services. The manner in which workers are paid also is relevant. For example, an arrangement that compensates a service provider by the hour is more indicative of an employer-employee relationship, whereas paying someone on a project basis is more common for self-employed contractors.
Workers classified as statutory employees are treated as self-employed when it comes to paying income taxes, but as employees for employment taxes. In other words, statutory employees have Social Security and Medicare taxes withheld from their payments similar to employees -- but not income taxes. The statutory-employee classification only applies to a very specific group of workers. This group of workers includes truck drivers who deliver food and beverage products and work on commission, persons who sell life insurance full-time, traveling salespersons and individuals who work at home assembling products if the necessary supplies and instructions are provided to them.
Proprietors, Partners and S Corporations
Most business owners are classified as self-employed -- but not all of them. Sole proprietors and partners, as well as limited liability company members who are taxed as sole proprietors and partners, are self-employed. This means their entire share of taxable business profits is treated as self-employment income. A shareholder of an S corporation, however, can be an employee of the business in which he owns shares. This means that he receives a regular salary for providing services and has employment and income taxes withheld from each paycheck. And when a shareholder takes a profit distribution from the S corporation, none of it is treated as self-employment income.
Self-Employment Tax Implications
When you earn self-employment income, it is reported to you on a 1099 form rather than a W-2 -- which only employees receive. Because you aren't subject to withholding, it is your responsibility to make sure quarterly estimated income tax payments are made and that each one is sufficient in amount -- which you can calculate using the worksheet on Form 1040-ES. If you earn $400 or more of self-employment income, you also will need to prepare a Schedule SE with your 1040 to determine the amount of self-employment tax you owe. The beneficial thing about self-employment income, however, is that you get to deduct your business expenses on Schedule C if your a sole proprietor, or Schedule E if you are a partner.
- Internal Revenue Service: Tax Topic 762
- Internal Revenue Service: Statutory Employees
- Internal Revenue Service: Self-Employed Individuals Tax Center
- Internal Revenue Service: Instructions for Form 1120S
- Internal Revenue Service. "Independent Contractor Defined." Accessed Oc. 20, 2020.
- Internal Revenue Service. "Self-Employed Individuals Tax Center." Accessed Oct. 20, 2020.
- Internal Revenue Service. "Independent Contractor (Self-Employed) or Employee?" Accessed Oct. 20, 2020.
- U.S. Equal Employment Opportunity Commission. "Coverage: Deciding Who Is Covered." Accessed Oct. 20, 2020.
- Marist College. "NPR Marist Poll National Nature of the Sample and Tables January 2018." Page 6. Accessed Oct. 20, 2020.
- Internal Revenue Service. "Tax Information for Partnerships." Accessed Oct. 20, 2020.
- Internal Revenue Service. "Sole Proprietorships." Accessed Oct. 20, 2020.
- Quick Books. "2019 Gig Economy and Self-Employment Report." Page 7. Accessed Oct. 20, 2020.
- Quick Books. "2019 Gig Economy and Self-Employment Report." Page 5. Accessed Oct. 20, 2020.
- Internal Revenue Service. "Self-Employment Tax (Social Security and Medicare Taxes)." Accessed Oct. 20, 2020.
Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.