If you’re a freelancer, it’s critical to know whether you’re self-employed or an employee. The distinction has a major effect on your tax responsibilities.
Categories of Self-Employed Workers
You should consider tax and other factors when choosing a legal structure for your business.
Generally, the Internal Revenue Service (IRS) considers you to be self-employed if you fall into any of these categories of individuals who carry on a trade or business:
- Sole proprietor
A “solo” is one person who owns an unincorporated business.
- Limited Liability Company (LLC)
An LLC combines some tax and other advantages of a corporation and a partnership. An LLC can consist of a sole member.
- Independent contractor
Generally, you might be an independent contractor if you have the power to decide when, where, and how you work on a specific project. If you fall into this category, you might also refer to yourself as a freelancer.
- Member of a partnership
A partnership is comprised of at least two people engaged in a business who share the profits and losses from that business.
Self-Employed on a Part-Time Basis
It’s important to understand you don’t have to work full-time in your business venture to be classified as self-employed.
You might work for one employer, but you’re also self-employed performing tasks or services for several freelance clients.
For example, you could be a project manager at a traditional 9-to-5 job with a side gig as a consultant or public speaker.
Why It Matters Whether You’re Self-Employed
If you’re self-employed, your tax position is vastly different than a traditional employee’s.
The major distinction is that self-employed individuals are responsible for paying their own taxes.
If you’re traditionally employed, your employer must withhold income tax and amounts for Medicare and Social Security from your paycheck. They are responsible for reporting and remitting those dollars to the tax authorities.
When you work for yourself, those company responsibilities are now your own.
Tax Reporting
When you work for a traditional employer, they mail a Form W-2, Wage and Tax Statement, to any employee that earned at least $600 in wages at the end of the year.
However, when you freelance, the situation is a bit different. A freelance client sends a Form 1099-MISC, Miscellaneous Income, to any freelancer they paid at least $600 for a dedicated project or service.
Additionally, if you were paid via a payment card or third party payment company (e.g., PayPal, Stripe, Square) for at least $20,000 and at least 200 transactions you should receive a Form 1099-K, Payment Card and Third Party Network Transactions, from each entity that met those thresholds.
NOTE: If a third party payment company properly sends you a Form 1099-K, the freelance client should NOT also issue you a Form 1099-MISC. Otherwise, your income is taxed twice.
Self-Employed Tax Responsibilities
If you’re self-employed, you’re required to pay the IRS (and possibly state taxing authorities) directly. You don’t have an employer to take care of it for you.
In addition, you may be required to pay your taxes on a quarterly basis rather than annually on the mid-April filing date. That’s because the IRS expects you to pay the taxes you owe as you earn the money.
Whenever you start working on a project, immediately determine how you should be classified in that particular work situation. Promptly pay your taxes if you’re self-employed.
As a business owner, you want to lessen the possibility of a stressful tax audit and concentrate instead on growing your business.
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