Did you know that the difference between self-employed vs. small business owner can significantly affect your business expenses, the personal liability you’re exposed to and how you file taxes?
You might have used the two terms interchangeably, but according to the IRS, these two classifications can mean different things when reporting your income and filing taxes.
We’ll explore the differences between being self-employed and becoming a small business owner. Continue reading to learn more about:
- How self-employed persons and small business owners are defined
- The difference between self-employed individuals and small business owners
- Pros and cons of each classification
- Tax requirements of self-employed vs. small business owner
- Insurance considerations for both designations
How is self-employed defined?
A sole proprietor is a one-person business without a separate legal entity like a corporation or LLC. You are the only business owner and are fully responsible for all financials, including any potential debt.
A sole proprietorship is typically the easiest business type to start. Even if you haven’t registered your business with the state, but have income and expenses that are separate from your regular household expenses, then you have a sole proprietorship. This includes people who make things, teach classes, sell products or provide services of any kind.
A general partnership is similar to sole proprietors in that there is no separate legal entity from the individuals in the partnership. They are responsible for all financials and are not considered employees for tax purposes.
An independent contractor works for another person or business, but is not considered an employee. An independent contractor can be registered as any type of business entity, but in practice, most are registered as sole proprietors.
Basically, owners and shareholders of corporation business structures are not considered self-employed. Regardless of how you are self-employed, the primary characteristic is that your business cannot expand beyond your individual capacity.
How is small business ownership defined?
Small business ownership is characterized by having other self-employed individuals work for you as independent contractors or by hiring others as employees.
If you have employees — both part-time and full-time — you oversee their taxes. You are also responsible for having the right workers' compensation coverage to meet your state's requirements.
Many businesses may start off as self-employed, especially freelance and consulting types, and as business grows, they expand to become small business owners.
Small business ownership and LLCs
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).
Where things get confusing is that you can be self-employed and form an LLC. From the IRS:
An individual owner of a single-member LLC that operates a trade or business is subject to the tax on net earnings from self employment in the same manner as a sole proprietorship.
Most states allow single-member LLCs, but LLC ownership can also be comprised of individuals in a business partnership.
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 owners have limited personal liability for business debts and obligations.
What is the difference between self-employed and small business owner?
Generally, when you’re self-employed, you are the business — everything from how much you work to when you work comes down to you. When you are a small business owner, you’re viewed as running as business as you likely have others working for you. Small business owners tend to give up some of their control in order to manage others.
Self-employed vs. business owner: pros and cons
Some of the benefits of being self-employed:
Benefits of being self-employed
Drawbacks of being self-employed
If you stop working, you stop earning — no paid leave for holidays or sick days
Low startup costs
Debts of the business are the debts of the owner
Responsibility for invoicing and collecting money
Self-employment tax deductions
No minimum wage to fall back on
No vacation or retirement plan benefits
Some of the benefits of being a small business owner:
Benefits of being a business owner
Drawbacks of being a business owner
More complex to set up and harder to run
The business is a separate entity from its owner, meaning different legal obligations and personal financial risks
Despite the benefit of being personally dissociated from certain liability, there is still entrepreneurial risk involved
The ability to delegate tasks to employees
Responsible for employee payroll
The chance to make more money than if you were employed by someone else
Responsible for employee requirements including taxes and workers' compensation
Taxes for small business and self-employed
One of the most significant differences is between self-employed vs. small business owners is how each pays taxes.
Self-employed individuals are responsible for filing a self-employed tax return. They must pay self-employment tax and file Schedule SE (Form 1040 or 1040-SR) when their net profit (calculated by subtracting your business expenses from your business income) is greater than $400 annually.
They must also pay self-employment tax, which is the Social Security and Medicare tax that is usually withheld from a full-time employee's paycheck.
Many self-employed workers file quarterly estimated 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 the end of the tax year, use Schedule C to report your profit and loss. Taxes can be complicated and there are many deductions for being self-employed. Contact a licensed bookkeeper or accountant for guidance.
In a self-employed partnership, taxes are paid by each member of the partnership based directly on his or her income or losses.
Small business owner taxes
Taxes for business owners are somewhat more complicated. Different types of businesses have their own sets of requirements.
For example, the chief benefit of LLC taxation is that taxes are paid through the personal returns of the owner(s), and rates may be lower than the rates paid by corporations.
If the business is setup as a corporation, they will pay corporate taxes — a tax on the business’s profits.
One of the biggest responsibilities a small business owners has vs. a self-employed person is they must use Form W-2 to report their employees’ incomes and how much federal, state or local income tax was withheld.
Similarly, if a small business owner hires independent contractors, they must report payments of $600 or more using Form 1099-MISC or Form 1099-NEC.
Insurance for small business owners vs. self-employed
Small business owners and self-employed workers can both benefit from business insurance. Lawsuits can cost small businesses anywhere between $3,000 and $150,000, according to the Small Business Administration.
For unincorporated small business owners or contractors whose business gains and losses are tied to personal finances, small business insurance can offer vital protections.
For example, general liability insurance can protect you from costs associated with common accidents that result in an injury or property damage to anyone who is not an employee.
If you own or rent a workspace, you may need insurance to help protect what’s inside and avoid a large financial loss. Commercial property insurance can help protect the physical assets you need to operate your business, including inventory, business equipment and furniture, and the structure itself.
A commercial auto policy is required in every state for business-related driving, and professional liability insurance can provide financial protection if you are accused of making a work mistake that leads to an injury or financial damages.
Workers' comp insurance is almost always required when you have one or more employees and it provides important benefits for self-employed workers if you opt for business owner's coverage.
How NEXT helps both self-employed and business owners thrive
NEXT provides an easy online option for small business owners and self-employed professionals to purchase business insurance. We provide affordable, customized insurance packages for 1,300+ professions.
Whether you’re setup as a sole proprietorship or as an LLC business, you can manage your coverage 24/7 with easy DIY access. Everything is 100% online, so you can get an instant quote, review options, buy coverage and get your certificate of Insurance in less than 10 minutes.