What Does Self-employed Mean?

You run your own business, but are you considered self-employed? The definition of self-employment can be confusing.

What does self-employment mean? Find out below.

Self-employed meaning

Self-employed people are those who own their own businesses and work for themselves.

According to the IRS, you are self-employed if you act as a sole proprietor or independent contractor, or if you own an unincorporated business. This means you are self-employed if your business is one of the following business structures:

• Sole proprietorship
• Partnership
• Limited liability company (LLC)

Who is not self-employed?

Other business structures do not have self-employed people, even if you are the owner. Corporations do not have self-employed people. This includes partnerships and LLCs that are taxed as corporations.

Business taxes for the self-employed

When you are self-employed, you must still pay business income taxes. In this case, the taxes pass through the business and on to you. You pay taxes on business income with your personal tax return. These are called pass-through taxes.

Below is more information about how to pay business taxes when self-employed.

Sole proprietorships and single-member LLCs

Sole proprietors and owners of a single-member LLC must report business profits, losses, and taxes on Schedule C or Schedule C-EZ of their Form 1040. You will send in the Schedule C when you submit your personal tax return.

Partnerships and multiple-member LLCs

Partners in a partnership and members of a multiple-member LLC must first prepare Form 1065, U.S. Return of Partnership Income. Then, the business should give a Schedule K-1 of Form 1065 to each member. Schedule K-1 shows each partner’s share of the business’s profits and losses.

When the members file their personal tax returns, they should include information from Schedule K-1. This information will help determine how much each member owes in taxes on the business’s income, Social Security tax, and Medicare tax.

Estimated taxes

When an employee is paid, the employer withholds taxes from their paychecks. But when a self-employed person is paid, there is no one withholding taxes from the payments.

Instead, self-employed individuals must pay estimated taxes, especially if they anticipate owing $1,000 or more when filing their income tax returns. These estimated taxes will go toward your personal and business income taxes.

You can use Form 1040-ES to calculate and pay your estimated taxes. Estimated taxes are due on a quarterly basis.

Business expenses

You can deduct the costs of operating your business. To deduct a business expense, it must be both ordinary and necessary.

Recordkeeping

You should keep all accounting records to help you complete your taxes. This includes your income statement, invoices, bank statements, receipts, etc. You can look these over if you have any questions or discrepancies when reporting and paying your taxes.

Having accurate records can help you take business tax deductions, such as mileage and travel expense deductions. By looking at your records, you can determine if you qualify for deductions and how much you can deduct. The records also serve as proof that you deserve the deductions, in case you are audited.

How to be self-employed

Being self-employed can be stressful but also incredibly rewarding.  Get your business off to a good start by following the six steps below.

1. Choose a business structure

If you want to be self-employed, your business structure must be one of the following:

• Sole proprietorship
• Partnership
• Limited liability company (LLC)

Other types of business structures do not have self-employed individuals. These structures are corporations, including partnerships and LLCs that are taxed as corporations.

Before you become self-employed, you must choose a business structure. Depending on your structure, you likely need to fill out documents and apply for a business license. And, you might need to apply for identification numbers.

2. Open a bank account

Separating your personal expenses from your business expenses is an absolute must for self-employed individuals.

Failing to keep personal and business expenses separate can lead to accounting, tax, and reporting issues. Not to mention, compiling expenses and income in one account can lead to overspending and disorganized accounting records.

To avoid problems in the future, open a small business bank account.

Before you open an account, do your research. Look at different banks to see what options they offer. After you determine your banking institution, gather documentation about your business (e.g., business name, licenses, etc.).

Typically, you can open your business bank account online or in person. Either way, you likely need to pay the bank a fee to open your new account.

If you’re planning on raising capital and borrowing money to grow your business, you can check with your bank about getting a business loan.

3. Set up accounting

Setting up an accounting method is essential for all business owners, regardless of whether you’re self-employed. Tracking income and expenses allows you to see your business’s financial health and organize your records.

While choosing an accounting method, you must decide between accounting software, manual bookkeeping, or hiring a bookkeeper.

Accounting software lets you record income and expenses with a few clicks of a button. Software is less time-consuming than manual accounting entries. And, using software decreases your odds of user-error and miscalculations.

Manually tracking your accounts can save you money. However, it is very tedious and stressful if you are not familiar with accounting.

Hiring a bookkeeper can be expensive. However, using a bookkeeper ensures your books are accurate. And, you don’t have to worry about handling your books yourself.

Before setting up a method, determine the pros and cons of each. Ask yourself questions like, Will I have time to add all of my entries manually? Can I afford accounting software? How much accounting knowledge do I have?

4. Create a business budget

As a self-employed individual, creating a business budget can help you stay on track and keep your finances in order. And, budgeting helps you plan for your business’s future.

To craft your small business budget, whip out a notepad and pen or start a spreadsheet on your computer. Keeping a physical document that lists your expenses and finances can help you stick to your budget.

In your budget, include sections such as revenue, expenses (e.g., fixed and variable expenses), and profits.

Regularly review your business budget, such as once per month or quarter. As your business grows, adjust your budget accordingly.

5. Pay income and withholding taxes

When you work for a business, your employer withholds payroll taxes from your wages. But when you’re self-employed, you are responsible for handling your payroll and business income taxes.

Pay estimated withholding taxes, especially if you anticipate owing $1,000 or more in income taxes. The estimated taxes go toward both your personal and business income taxes. Do not make estimated payments if you do not owe more than $1,000 in taxes.

Each business is also required to fill out certain forms for business income taxes, depending on your type of business structure. Be sure to fill out the correct forms for your business. Check out a breakdown of the different forms for each self-employed structure below.

• Sole proprietors and single-member LLCs: File Schedule C along with Form 1040
• Partnerships and multiple-member LLCs: File Form 1065 and distribute Schedule K-1 to each member

6. Look into tax deductions

Self-employed individuals can claim tax deductions for:

Depending on your business and types of expenses, you might be able to take advantage of some deductions. To learn more about which deductions apply to you, contact the IRS or reach out to an accounting professional.

Small business accounting software will help you track your business profits and losses. With Patriot Software’s accounting software, you can easily record payments, track expenses, and create invoices. Try it for free today!

This article is updated from its original publication date of June 12, 2018.

This is not intended as legal advice; for more information, please click here.