How to Become (And Stay) Self-Employed, According to the Law

By Nicole D

When Are You Considered "Self-Employed"?

You're generally classified as self-employed if you are in business for yourself, carry on a trade or business as a sole proprietor or independent contractor, or own a part-time business in addition to your regular job.  Self-Employed individuals are also called consultants, freelancers, or independent contractors.


How Do I Become Self-Employed?

You can learn the steps you must take to legally operate a small business as a self-employed individual on Business.gov.  These steps are similar to starting any business - obtain licenses and permits, establish a business name, finance your business- but with a few specific tax and benefit implications that apply to the self-employed.

Generally, you and your clients will decide your work arrangement when you are hired to do a job.  If you are brought on as an employee, you will likely undergo on-the-job training and receive employment benefits.  If you are brought on as an independent contractor, you will not receive employee benefits or the same legal protections as employees, and often responsible for your own expenses.

Because of the tax and employee rights implications in declaring self-employment status, it's common for the IRS and various state agencies to occasionally review your work status to ensure that you are indeed self-employed and not an employee of your client's business.  The IRS offers guidance on how to determine if you are considered an employee or self-employed.

A few states pay a weekly allowance to help unemployed workers start their own small businesses.  For more information about Self-Employment Assistance Programs, read on at the Department of Labor.


Stay Abreast of Tax Requirements for the Self-Employed

If you are self-employed you must pay a self-employment tax (SE tax). Similar to the social security and Medicare taxes withheld from an employee paycheck, the SE tax is primarily for those who work for themselves. 

You will also pay estimated taxes. Estimated tax is the method used to pay tax on income that is not subject to withholding. Even if you also have a full-time or part-time job and your employer withholds taxes from your wages, you still need to pay estimated taxes. If you don't make quarterly payments you can be penalized for underpayment at the end of the tax year.


Already Self-Employed?  Preserve Your Self-Employed Status

It's important to ensure that state or federal agencies don't interpret you as an employee in an audit - that determination could cost you client work, in addition to time and money you'll spend trying to petition the assessment.  There are simple, but important, actions you can take to preserve your self-employed status:

- Create a client contract that proves you and your client intended for you to work as an independent contractor, not as an employee.
- Juggle multiple clients at the same time, or over the course of the year, which will show you do not have permanent employment with one firm.
- Show risk of loss by incurring regular business expenses. This shows auditors that you could stand to lose money if you don't have enough regular work.
- Control the means and methods of accomplishing the work. If your client dictates how you do your work, you may be viewed as an employee. The general rule from the IRS is that in an independent contractor arrangement, a client has the right to control or direct only the result of the work, not how that work is accomplished.
- Secure your own employment benefits. As tempting as it may sound, accepting employment benefits like health insurance or paid vacations from your clients can negatively impact your self-employed status.
 

Other Issues for the Self-Employed

- Retirement Planning: The advantages of a retirement plan are numerous - economic, business and tax advantages for your business, for your employees and for you. A retirement plan may give you an important competitive edge in attracting and keeping the best employees - and help you plan for your own retirement years. The retirement plans videos from the IRS are also a great resource for choosing, operating and maintaining your retirement plan.
- Intellectual Property: Self-Employed individuals should be aware of the ownership rights of the copyrights, patents, and trade secrets you create for clients. Read more about intellectual property rights on Business.gov.