Self-Employed vs. Small Business Owner: Why the Difference Matters


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The differences between the self-employed and small business owners may appear subtle, but they can impact your expenses, liability, and taxes. Being a small business owner comes with additional challenges and responsibilities that self-employed individuals do not have. In this article, we define what it means to be self-employed and a small business owner, highlight the pros and cons of each, and explore two key differences.

What It Means to be Self-Employed

To be self-employed means that you work for yourself. You are your own boss, you work when you want to (or need to) and where you want to– with some limitations. Being self-employed means that your business (and profit) does not depend on others; it's solely on you.

Three main categories of the self-employed are sole proprietorships, partnerships, and independent contractors.

  • Sole proprietorship. A sole proprietor is in essence, a one-person business. You are the business; there is no distinction made between you and your business for tax and legal purposes. You are considered the same legal entity. Sole props. can operate by their given name (John Smith) or use a fictitious name (John's Carpet Cleaning), known as a DBA.
  • Partnership. A partnership occurs when two or more people come together to conduct business. It's similar to a sole proprietorship in that there is no distinction made between the business and the owners or "partners."
  • Independent contractor. An independent contractor is someone who produces work for someone else but is not considered an employee. Independent contractors are often called freelancers because they can work for many different companies at once, or just one. They can decide to stop working for any business at any time–once their contract is finished.

The Pros and Cons of Being Self-Employed

Like any business model, there are positive sides and negative aspects to being self-employed. Here is a quick breakdown.
Self-employed Pros and Cons

Definition of a Small Business Owner

All business owners are self-employed, but not all self-employed are small business owners. While being self-employed is defined as being your own boss, being a small business owner is simply characterized by having others work for you. As a small business owner, you can hire independent contractors or employees.

If you decide to hire employees, you will have the obligation of collecting taxes, offering sick and vacation pay, and carrying workers' compensation insurance. You may eventually need to hire a human resources manager to ensure compliance with state and federal laws. Hiring an independent contractor is rather straightforward and does not require any tax withholding or benefits package.

The Pros and Cons of a Small Business Owner

Being a small business owner is a major accomplishment, but it too has positive and negative aspects. Here are some of the pros and cons of being a small business owner.
Small Business Owner Pros and Cons

Tax Considerations for Self-Employed and Small Business Owners

Both self-employed individuals and small business owners pay taxes, but the process is different. Self-employed individuals must pay self-employment tax as well as file a tax return each year. Since there is no employer to deduct Medicare and Social Security tax, you will pay that yourself via self-employment tax (assuming you make more than $400 per year).

The self-employed do not need to worry about business tax filings because the business profit is passed through to you and is accounted for on your personal taxes. Many self-employed individuals pay taxes quarterly to avoid a larger bill during tax season and avoid any potential penalties.

For a small business owner, the business tax that you pay depends on your business structure. A Limited Liability Company (LLC), for example, can elect to have its taxes passed through to the owner(s), just like a sole proprietorship. An LLC can also elect to be treated like a C-Corporation and pay corporate taxes. Once you begin hiring employees, you will be responsible for withholding your employees' federal, state, and local taxes (if applicable).

Insurance Considerations for Self-Employed and Small Business Owners

The self-employed and small business owners can both benefit from carrying business insurance and may be required to in some cases. Lawsuits can cost tens of thousands of dollars, even hundreds of thousands of dollars, depending on the offense. Even if you win the lawsuit, the attorney fees can be substantial.

Policies such as general liability, professional liability, a BOP (business owner's policy), and others are useful for the self-employed and small business owners alike. Unlike self-employed individuals, small business owners who have employees may need to carry workers' compensation insurance. Each state has its own regulations on worker's compensation insurance, so be sure to check your state's requirements.

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