Self Employed Law & Legal Definition


Self-employed refers to a person who operates a business or profession as a sole proprietor, partner in a partnership, independent contractor, or consultant. Self-employed individuals report their income on Schedule C of Form 1040. Self-employment typically involves bearing the expenses of hiring others to assist or do work on one's own behalf, having to personally bear the risk of success or failure of the business, and bearing responsibility for correcting unsatisfactory work. Self-employed individuals also usually have several customers at the same time , provide the main equipment needed to carry out the work, and can decide how, when and where work is done.

Additional Definitions

Self-Employment

Self-employment has always been a fundamental feature of American life, not just in colonial times and during early U.S. history—during which, of course, the predominant form of work was agriculture—but also in the most recent period of modern times since World War II. Data on self-employment are collected by the U.S. Bureau of Labor Statistics (BLS) as part of the Current Population Survey. The most recent such data are for the year 2003. In the period 1948 through 2003, those self-employed in non-agricultural industries have represented around 7 percent of total employment. The highest levels came in the early decades of this period, with 1948 being the highest year: 12 percent of all those working outside agriculture were working for themselves. The lowest level was reached in 2002 (6.7 percent), and, generally the trend has been downward. In 2003, 9.3 million individuals were self-employed and represented 6.9 percent of non-agricultural employment. Self-employment rates fluctuate up and down. They tend to rise during reces-sions—but sometimes also rise with the rising economy. Self-employment is highest in the agricultural sector where, in 1948, 61.1 percent of all workers were self-employed. In 2003, 951,000 agricultural workers, 41.8 percent of all those engaged in agriculture, worked for themselves.

LEGAL DEFINITIONS

Individuals who choose self-employment must be aware of the rules governing the treatment of free-lance employees (also known as independent contractors). Classification of someone as an employee or a self-employee is somewhat ambiguous and depends on several factors, including the degree of independence, the freedom to hire others to do the work taken on, the freedom to work for others, and the assumption of risks. Independent contractors typically accept no fringe benefits and pay Social Security, Medicare, and income tax installments directly. Employees have more statutory rights, benefits, and protections than subcontractors, who must generally provide these for themselves. But independent contractors have advantages in terms of freedom, flexibility, and tax deductions.

The IRS applies a 20-part test in order to determine whether a certain worker should be classified as an employee or an independent contractor. The main issue underpinning the test is who sets the work rules: employees must follow rules set by their bosses, while independent contractors set their own rules. For example, an individual who sets his own hours, receives payment by the job, and divides his time between work for several different employers would probably be classified as an independent contractor. Other criteria involve who provides the tools and materials needed to complete the work. For example, an individual who works at an employer's facility and uses the employer's equipment would be considered an employee, while one who works at a separate location and provides her own equipment would be classified as an independent contractor. Finally, an independent contractor usually pays his own expenses of doing business and takes the risk of not receiving payment when work is not completed in accordance with a contract, while an employee is usually reimbursed for business-related expenses by the employer and receives a paycheck whether his work is completed or not.

An individual's status as a self-employed, independent contractor can be reinforced by having multiple clients, being paid by the amount of work done rather than by the hour, or obtaining an employer identification number from the IRS. Working under a business name also helps reinforce this status. Printing invoices, business cards, and stationery can also help identify someone as a self-employed person. In general, the person must demonstrate that he or she is in business for the purpose of making a profit.

CHARACTERISTICS

Of those self-employed in industry (versus agriculture), slightly over half (51.5 percent) were working as incorporated entities. The self-employed are predominantly older. Among those unincorporated, those aged 24-44 represented 42 percent and those aged 44 and older 54.5 percent of this segment of the self-employed. Among those incorporated, the older were even more numerous, representing 58.5 percent of those over 44 and 42 percent of those in the 24-44 bracket. In the wages and salary-earning population as a whole the 24-44 group was 48.1 percent and those over 44 were 36.5 percent. The self-employed are overwhelmingly white (88.2 percent of unincorporated, 90.1 percent of those incorporated) and U.S. born (87 percent in both categories). The educational attainment of the incorporated self-employed was high in 2003. Of these individuals, on average, 72 percent had some college on up to advanced degrees; among the unincorporated 58 percent had such attainment, slightly below the wages and salary-earning population, of which 60 percent had some college or higher attainment. Males are more present in both categories, representing 62 percent of the unincorporated and 73 percent of the incorporated self-employed.

Beyond such demographic measurements, the motivation for self-employment is more difficult to determine. Motivations routinely mentioned by commentators no doubt rest on experience and observation—namely that some women choose self-employment to be more available to care for a member of the household. Some of the elderly continue working on their own as they reach retirement age—and beyond. A certain segment of the self-employed population is motivated by enterprise. Many, however, do not choose this type of work but do it as a way of coping with inability to find good jobs, especially in middle age. And of these some succeed well enough to found organizations and thus, after a period, migrate back into employment—but in companies that they now own. Fluctuations in self-employment data may in part be explained as an indirect effect of new business formation: these begin as single-person businesses but then become providers of wages and salaries—for the owners as for others.

SELF-EMPLOYMENT AND THE VERY SMALL BUSINESS

Elsewhere in this volume (see Small Business) are presented data on the so-called nonemployer businesses, labeled "the micros." In 2003, there were some 18.6 million such businesses grossing $830 billion in revenues, equivalent to $44,623 per entity. This number was twice as high as the 9.3 million self-employed persons in 2003—but also includes them. The self-employed, thus, are roughly half of the population of "micro" of business, the seedlings from which larger entities often emerge. But obviously many nonemployer businesses are also operated "on the side" by people employed in ordinary jobs but doing some trading, producing, and service providing in their spare time: moonlighting, in other words. In 2001, 7.8 million people reported working at multiple jobs. Of these, 4.6 percent (359,000) told the BLS that they were doing this in order to build a business or to get experience—preparing, perhaps, to launch their own operations. Nonemployer businesses grew by 20.8 percent between 1997 and 2003; during the same period, total employment increased 7.3 percent and self-employment by 3.1 percent, losing share, in other words. Thus it is plain that the growth of seedling businesses is far less attributable to self-employment than to entrepreneurial activity.

CONSIDERATIONS IN SELF-EMPLOYMENT

Self-employed individuals as a whole tend to work longer (an additional 17.5 hours per week, according to one study) and harder than their colleagues who are organizationally employed. Moreover, self-employed people often operate under uncertain payment schedules and must make outlays from personal earnings for insurance and retirement. In addition, their salaries and assets are dependent on their work contributions in a more intimate way than are those of their colleagues. The entrepreneurial role is also often more physically and psychologically stressful due to the investments in energy the jobs demand.

Isolation and Networking

Isolation often proves to be an important source of psychological strain for self-employed individuals. The environment of the typical self-employed individual is quite different from the corporate environment where many professionals gain their experience. This is one reason contact with supportive colleagues becomes crucial. Mentors can provide advice regarding business aspects of a new business owner's operation. Trade and professional organizations can be an excellent way to establish contacts with peers. Tenacity in networking has been cited as a key to survival for business owners, some of whom maintain databases of thousands of contacts. These contacts are also vital in referring clients and providing market information. The role of the contact is made more important as the self-employed individual typically has no staff for marketing support.

It is difficult to exaggerate the importance of referrals to the typical independent professional. Since relationships are so vital, one must exercise the utmost delicacy in terminating employment with one's former employer or turning down a job. One's former employer can even become a good client, besides providing valuable referrals. When turning down clients, the self-employed person can protect those relationships by making referrals or even subcontracting to other colleagues in their network. Provided the work done is of quality, this can strengthen one's reputation as a purveyor of talent—whether one's own or an associate's. When the client calls back with a more appropriate assignment, the contractor has the choice of the business.

As they begin their enterprises, many self-employed individuals feel compelled to accept a variety of assignments due to sheer scarcity of work. However, specialization can help ensure their long-term survival. For one thing, corporate clients can often find a generalist's abilities in-house. Also, specialization may allow professionals to broaden their client base geographically, thus freeing their fortunes from fluctuations in the local economy. These factors can enable the specialist to earn higher fees and work more consistently. Paradoxically, one's work as a specialist can garner referrals outside one's specialty, so specialization might not be as limiting as a strict definition would imply. The self-employed should be cautioned against changing their specialties too often, as this can confuse clients and make their own operations inefficient.

Tax Implications

Self-employment entails both tax advantages and disadvantages. In terms of advantages, individuals who are classified as independent contractors can deduct work-related expenses for tax purposes. In addition, independent contractors often qualify for tax deductions for using part of their home as an office and for salaries paid to other people, while employees usually do not. Independent contractors also can claim significant deductions for medical insurance, transportation, office supplies, and a host of other operating costs.

The main tax disadvantage for self-employed persons is that they must pay the full amount of Social Security and Medicare taxes themselves and make quarterly estimated tax payments to the federal government. For those who are organizationally employed, the employer withholds income taxes and pays half of their Social Security and Medicare taxes. Although the payment of Social Security and Medicare increases the tax burden of self-employed individuals, these amounts are based on net, rather than gross, earnings. For this reason, it is essential for small business owners to keep an accurate record of expenses. Self-employed individuals also file quarterly taxes.

INCREASING THE CHANCE OF SUCCESS IN SELF-EMPLOYMENT

Self-employment, whether by choice or necessity, does not guarantee success. In fact, nearly two out of every three new businesses fail within five years. But the chances of success can be improved with careful planning, prior savings, and a sound marketing strategy. It may also be helpful to make the transition to full-time self-employment gradually. As already mentioned, one option is to "moonlight" on the new job first. Those planning home-based businesses should also take time to prepare family members for the changes that will take place.

Some prospective new business owners also try to establish one stable client relationship that will provide steady income during the search for additional clients. A particularly attractive option may be an individual's former employer, who will already be familiar with the would-be entrepreneur's reputation and abilities. For this relationship to succeed, however, it is important that the individual use an honest and professional approach when severing ties with their employer. Of course, your employer may not react warmly to such an arrangement if your new business is a potential threat to its own financial fortunes.

Although one stable client relationship can help establish a new business, it is also important that the self-employed person develop a marketing strategy to find new clients and grow. Many new business owners become so busy serving their existing clients that they do not devote sufficient time to marketing. Sending out brochures, networking, and joining professional organizations are a few possible marketing strategies.

Finally, self-employed individuals should take an organized approach to all business activities in order to increase their chances of success. A business plan, however rudimentary, is often helpful to set the path ahead with some consciousness and formality. A plan can help a self-employed person evaluate strategies, plan expenditures, and motivate him or herself. It is also important to keep careful records of income and expenses, set aside money for taxes, and insist upon contracts for all work performed.

SEE ALSO Self-Employment Contributions Act (SECA); Small Business

BIBLIOGRAPHY

Hipple, Steve. "Self-Employment in the United States: An update."Monthly Labor Review. U.S. Department of Labor. 23 July 2004.

Karoly, Lynn A., and Julie Zissimompoulos. "Self-Employment Among Older U.S. Workers." Monthly Labor Review Online. U.S. Department of Labor. Available from http://www.bls.gov/opub/mlr/2004/07/art3exc.htm. July 2004.

"Moonlighting in 2001." Monthly Labor Review. U.S. Department of Labor. 16 October 2002.

U.S. Bureau of Labor Statistics. "Work at Home in 2004." Press Release. 22 September 2005.

U.S. Census Bureau News. "Small Business Week 2006." Press Release. 27 March 2006.

                                 Hillstrom, Northern Lights

                                   updated by Magee, ECDI