Self-employed

Self-employment can be referred to a person who works for himself/herself instead of as an employee of another person or organization, drawing income from a trade or business.


SELF-EMPLOYMENT LAW IN THE UNITED STATES

Taxation in the U.S.

In the United States self-employed workers are paid directly by clients or by their business, and some proportion of these payments will be due to the government as income tax.

In the United States, a person running a business as a sole proprietorship or a limited liability company is considered self-employed for tax purposes, but the sole shareholder of an S Corporation is not considered self-employed. Such a person is considered an employee of the corporation and does not pay self-employment tax, but instead pays FICA tax (matched by the corporation) at half the tax rate at which the self-employment tax is imposed -- 7.65% each by employer and corporation, instead of the 15.3% self-employment tax.

The self-employed in the United States are usually required to pay estimated income taxes quarterly. They pay both the employee and employer portions of the FICA tax (which pays for Social Security and Medicare), since they are considered both the employer and the employee. An employed person pays 7.65% (6.2% for Social Security and 1.45% for Medicare) through a paycheck deduction, and the employer pays the other 7.65%. The self-employed person pays both sides of this tax, or 15.30% total. However, since half of the hypothetical self-employment tax is allowed as a deduction against self-employment income, only 92.35% of the self-employment income is taxable at 15.30%, an effective tax rate of about 14.13%. This tax is reported on Schedule SE of the IRS Form 1040.

Many self-employed choose to incorporate to reduce this tax. Before incorporation, a self-employed person making $100,000 in business profit would pay 15.30% of that profit in self-employment tax, or $15,300. But with an incorporated business, the business can pay the owner $50,000 in salary and $50,000 in dividends (called "distributions"). The owner pays 7.65% of the $50,000 in salary and his/her corporation pays the other 7.65%, for $7650 total. Distributions are not subject to self-employment tax, so there is no FICA/Medicare tax on the $50,000 in distributions. Thus the business owner may save $7,650 in taxes. However, tax laws can be tricky, and do change, so it is usually advisable to seek the advice of a competent accountant in taking the decision to incorporate for the purpose of saving tax. (Note, however, that the above example is slightly over-simplified -- the 12.4% OASDI portion of the self-employment tax, or the 6.2% OASDI portion of the FICA tax applies only to the OASDI wage base, which is the first $94,200 of self-employment income in 2006, or $97,500 in 2007. The 2.9% Medicare portion of the self-employment tax and the 1.45% Medicare portion of the FICA tax applies to all self-employment income.)

Self-employed persons are sometimes eligible for more deductions than an ordinary employee. Travel, uniforms, computer equipment, cell phones, etc., can be deducted as legitimate business expenses. However, again, the advice of an expert may be worth the money it costs.

Self-employed persons report their business income or loss on Schedule C of IRS Form 1040 and calculate the self-employment tax on Schedule SE of IRS Form 1040.


Self-employed 401k retirement account

Self-employed workers cannot contribute to a 401k plan of the type with which most people are familiar. However, there are various vehicles available to self-employed individuals to save for retirement. Many set up a Simplified Employee Pension Plan (SEP) IRA, which allows them to contribute up to 25% of their income, up to $44,000 (2006) per year. There is also a vehicle called the Self-Employed 401k or SE 401k for self-employed people. The contribution limits vary slightly depending on how your business is organized but are generally higher than the other types of plans.


SELF-EMPLOYMENT LAW IN THE UNITED KINGDOM

A self-employed person in the United Kingdom can operate as a sole trader or as an incorporated limited liability company. It is also possible for someone to form a business that is run only part-time or concurrently while holding down a full time job. This form of employment, while popular, does come with several legal responsibilities. When working from home clearance is required from the local authority to use part of the home as business premises. Should the business hold records of customers or suppliers in any electronic form it is required to register with the Data Protection Registrar. Other legal responsibilities include statutory public liability insurance cover, modifying premises to be disabled friendly, and the proper recording and accounting of financial transactions. Free advice on the range of responsibilities is available from government operated Business Link centres.


Taxation in the UK

Self employed may be subject to more taxes than the average employee. In addition to both the employee and employer National Insurance contributions, there may be VAT, business rates and other taxes payable to central and local governments.

Both in the US and the UK governments are cracking down on disguised employment, often described as the pretence of a contractual intra-business relationship to hide what is otherwise a simple employer-employee relationship.


SELF-EMPLOYED INDIVIDUALS: FAQ

Below you will find information helpful in answering many questions related to being self-employed individuals or independent contractors.


Who is Self-Employed?

If you are in business for yourself, or carry on a trade or business as a sole proprietor or an independent contractor, you generally would consider yourself a self-employed individual. You are an independent contractor if the person for whom you perform services has only the right to control or direct the result of your work, not what will be done or how it will be done.

For more information see... Who is Self-Employed?


Do I Need an Identification Number?

You must have a taxpayer identification number to operate your business. This is generally your social security number, or an individual taxpayer number. However if you have employees, and in some other circumstances, you will need an Employer Identification Number.

For more information see... Do I Need an Identification Number?


Filing Requirements for the Self-Employed

As a self-employed individual, you may be responsible for completing multiple tax forms, depending on your type of business.

For more information see... Filing Requirements for the Self-Employed


IRS e-file for Business and the Self-Employed

Electronic filing and payment options for businesses and self-employed individuals including employment taxes, information returns, partnerships returns, and returns for estates & trusts. You can also electronically file corporate tax returns (Forms 1120/1120S), and returns for exempt organizations (Forms 990/990EZ & 1120 POL).

For more information see... IRS e-file for Business and the Self-Employed


Publications and Forms for the Self-Employed

A collection of relevant forms and publications related to understanding and fulfilling your filing requirements.

For more information see... Publications and Forms for the Self-Employed


Where to File Addresses

Where to file addresses for individuals, businesses, and tax practitioners.

For more information see... Where to File Addresses


Operating a Business

Learn about the various responsibilities associated with operating your own business. You will find many topics, such as: types of business taxes that may apply, how to structure retirement plans for your employees, deducting the cost of running your business, and much more.

For more information see... Operating a Business


Closing a Business

There is more involved in closing your business than just locking the doors. This section provides procedures for getting out of business, including what forms to file and how to handle additional revenue received or expenses that you may incur.

For more information see... Closing a Business


Tax Trails

Quick and interactive, answer a few yes or no questions and you have insight into your deductions, credits, and more.

For more information see... Tax Trails


Earned Income Tax Credit

If you file a Form 1040 Schedule C, you may be eligible to claim the Earned Income Tax Credit.

For more information see... Earned Income Tax Credit


STARTING A SMALL BUSINESS

Most businesses start out small. As a new business owner you need to know your federal tax responsibilities. This page provides links to basic federal tax information for people who are starting a business. It also provides information to assist in making basic business decisions. The list should not be construed as all-inclusive. Other steps may be appropriate for your specific type of business.

For more information see... Starting a business


EXTERNAL LINKS

The National Association for the Self-Employed (U.S.)
National Association for the Self-Employed