Self-employment is the state of working for oneself rather than an employer.
Generally, tax authorities will view a person as self-employed if the person chooses to be recognized as such, or is generating income such that the person is required to file a tax return under legislation in the relevant jurisdiction. In the real world, the critical issue for the taxing authorities is not that the person is trading but is whether the person is profitable and hence potentially taxable. In other words, the activity of trading is likely to be ignored if no profit is present, so occasional and hobby- or enthusiast-based economic activity is generally ignored by authorities.
Self-employed people generally find their own work rather than being provided with work by an employer, earning income from a trade or business that they operate.
In some countries governments (the United States and United Kingdom, for example) are placing more emphasis on clarifying whether an individual is self-employed or engaged in disguised employment, often described as the pretense of a contractual intra-business relationship to hide what is otherwise a simple employer-employee relationship.
Self-employment in the United States
Although the common perception is that self-employment is concentrated in a few service sector industries, like sales people and insurance agents, research by the Small Business Administration has shown that self-employment occurs across a wide segment of the U.S. economy. Furthermore, industries that are not commonly associated as a natural fit for self-employment, such as manufacturing, have in fact been shown to have a large proportion of self-employed individuals and home-based businesses.
In the United States, any person is considered self-employed for tax purposes if that person is running a business as a sole proprietorship, independent contractor, as a member of a partnership, or as a member of a limited liability company that does not elect to be treated as a corporation. In addition to income taxes, these individuals must pay Social Security and Medicare taxes in the form of a SECA (Self-Employment Contributions Act) tax.
Different types of self-employment
There are many different ways in which one can be self-employed in the United States. Self-employment is a specific form of labor market activity with a particular tax classification spanning hundreds of different occupations and industries. So artists, musicians, accountants, doctors, mechanics, real estate agents, consultants, lawyers, IT software developers, etc. can all be classified as self-employed. Many self-employed individuals have employees who work for them as in the case of small business owners. One ways to differentiate self-employment is by industry-sector. So, one can be self-employed in manufacturing, retail trade, professional services, personal services, or finance. While all forms of self-employment offer independence and autonomy for self-employed individuals, the rewards and income generation vary dramatically by industry.
Self-employment among immigrant and ethnic minorities
Self-employment is relatively common among new immigrants and ethnic minorities in the United States. In the United States, immigrants tend to have higher rates of self-employment than native-born Americans regardless of race or ethnicity. But, self-employment in the United States is unevenly distributed across racial/ethnic lines. Immigrants and their children who self-identify as White have the highest probability of self-employment in lucrative industries such as professional services and finance. In contrast, racial and ethnic minorities are less likely than native-born Whites to be self-employed, with the exception of Asian immigrants who have a high rates of self-employment in low prestige industries such as retail trade and personal services. Much like the regular labor market, self-employment in the United States is stratified across racial lines. In general, self-employment is more common among immigrants than their second-generation children born in the United States. However, the second-generation children of Asian immigrants may continue to seek self-employment in a variety of industries and occupations.
The self-employment tax in the United States is typically set at 15.30%, which is roughly the equivalent of the combined contributions of the employee and employer under the FICA tax. The rate consists of two parts: 12.4% for social security and 2.9% for Medicare. The social security portion of the self-employment tax only applies to the first $110,100 of income for the 2012 tax year. There is no limit to the amount that is taxable under the 2.9% Medicare portion of the self-employment tax.
Generally, only 92.35% of the self-employment income is taxable at the above rates. Additionally, half of the self-employment tax, i.e., the employer-equivalent portion, is allowed as a deduction against income.
The 2010 Tax Relief Act reduced the self-employment tax by 2% for self-employment income earned in calendar year 2011, for a total of 13.3%. This rate will continue for income earned in calendar year 2012, due to the Temporary Payroll Tax Cut Continuation Act of 2011. Self-employed persons sometimes declare more deductions than an ordinary employee. Travel, uniforms, computer equipment, cell phones, etc., can be deducted as legitimate business expenses.
Self-employed persons report their business income or loss on Schedule C of IRS Form 1040 and calculate the self-employment tax on Schedule SE of IRS Form 1040. Estimated taxes must be paid quarterly using form 1040-ES if estimated tax liability exceeds $1,000.
401k retirement account
Self-employed workers cannot contribute to a company-run 401k plan of the type with which most people are familiar. However, there are various vehicles available to self-employed individuals to save for retirement. Many set up a Simplified Employee Pension Plan (SEP) IRA, which allows them to contribute up to 25% of their income, up to $54,000 (2017) per year. There is also a vehicle called the Self-Employed 401k (or SE 401k) for self-employed people. The contribution limits vary slightly depending on how your business is organized but are generally higher than the other types of plans.
A defined benefit plan is a third option that has high contribution limits and acts like a traditional pension plan. Sole Proprietors can also opt for a SIMPLE IRA, which allows them to contribute to employee retirement plans as well as their own retirement plan.
Effects on income growth
Research has shown that levels of self-employment in the United States are increasing, and that under certain circumstances this can have positive effects on per capita income and job creation. According to a 2017 study by MBO Partners, the self-employed workforce generates $1.2 trillion in revenue for the U.S. economy, which is equal to about 6% of national GDP. A 2011 study from the Federal Reserve Bank of Atlanta and Pennsylvania State University looked at U.S. self-employment levels from 1970 to 2000. According to data from the U.S. Bureau of Economic Analysis, the absolute number of people registered as non-farm proprietors (NFPs) or self-employed in metropolitan counties grew by 244% between 1969 and 2006, and by 93% in non-metropolitan counties. In relative terms, the share of self-employed within the labor force grew from 14% in 1969 to 21% in 2006 in metropolitan counties, and from 11% to 19% in non-metropolitan counties.
In non-metropolitan counties, the study found that increased levels of self-employment were associated with strong increases in per capita income and job creation and significant reductions in family poverty levels. In 1969, the average income of non-farm proprietors was $6,758 compared to $6,507 earned by salaried employees; by 2006 the difference in earnings widened to $12,041 in favor of salaried employees. The study notes that the gap could be due to underreporting of income by the self-employed. Alternatively, low-productivity workers could be losing their jobs and are forced to be self-employed. Further, some research shows that higher local unemployment rates lead workers to self-select into self-employment, as does past unemployment experience.
Self-employment in the United Kingdom
See also: Employment contract in English law
According to a 2016 study by the McKinsey Global Institute, there are 14 million independent workers in the United Kingdom. A self-employed person in the United Kingdom can operate as a sole trader or as a partner in a partnership (including a limited liability partnership or "LLP") but not through an incorporated limited (or unlimited) liability company. It is also possible for someone to form a business that is run only part-time or concurrently while holding down a full-time job. This form of employment, while popular, does come with several legal responsibilities. When working from home, clearance may sometimes be required from the local authority to use part of the home as business premises. Should the self-employed person hold records of customers or suppliers in any electronic form they will be required to register with the Information Commissioner's Office. Other legal responsibilities include statutory public liability insurance cover, modifying premises to be disabled-friendly, and the proper recording and accounting of financial transactions. Free advice on the range of responsibilities is available from government operated Business Link centres.
Many people living with disabilities choose to be self-employed.
Self-employment in the European Union
The European Commission defines a self-employed person as someone: “pursuing a gainful activity for their own account, under the conditions laid down by national law”. In the exercise of such an activity, the personal element is of special importance and such exercise always involves a large measure of independence in the accomplishment of the professional activities. This definition comes from Directive 2010/41/EU on the application of the principle of equal treatment between men and women engaged in an activity in a self-employed capacity. This is in contrast to an employee, who is subordinate to and dependent on an employer.
In addition, Article 53 of the Treaty on the Functioning of the European Union (TFEU) provides for the free movement of those taking up and pursuing activities as self-employed people. It stipulates: “In order to make it easier for persons to take up and pursue activities as self-employed persons, the Council shall… issue Directives for the mutual recognition of diplomas, certificates and other evidence of formal qualifications”.
The self-employment form of work does not group homogenous workers. As indicated by the European Commission in 2010, there are “different understandings and definitions of the term self-employment across the countries, with a number of different subcategories defined: for instance, according to the legal status of the enterprise, whether the business has employees or not (employers versus own-account workers) and/or the sector in which the business operates. Some countries also make the distinction between self-employed status and the status of ‘dependent self-employed’ (e.g. Spain, Italy), where the self-employed person works for only one client. Others distinguish self-employment which is carried out in addition to paid employment (e.g. Belgium)”.
The EN European Parliament Resolution on Social Protection for All has stated that: “the absence of a clear national definition of self-employment increases the risk of false self-employment” and the European Parliament Resolution on the Renewed Social Agenda invites Member States to take initiatives that would “lead to a clear distinction between employers, genuine self-employed and small entrepreneurs on the one hand and employees on the other”.
Self-employment is mostly regulated at national level only. Each authority and individual body applies its own legal and regulatory framework provisions, which may vary depending on their remit or policy area (tax law, social security, business law, employment market, insurance). The provisions related to self-employment vary therefore widely between the countries. As indicated by Eurofound in 2014, the diversity of the self-employed has attracted diverse forms of regulation, mainly decided at national level: “EU employment law addresses the self-employed mainly in narrowly specific areas such as free movement and equal treatment”.
As recommended by the European Forum of Independent Professionals (EFIP), the EU, employers’, employees’ and self-employment representatives should adopt a Europe-wide joint recognition of genuine self-employment and a common definition that includes a shared terminology for the various sectors.
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Three essays on self-employment
Doctor of Philosophy (PhD)
Self-employment, Population density, Entrepreneurship, Human capital, Earnings
Entrepreneurial and Small Business Operations | Labor Economics
This dissertation is a collection of three essays, each of which examines different aspects of self-employment. The different analyses use different sources of data and various econometric methods to test issues related to US entrepreneurship.
In the first essay, I use NSCG (National Survey of College Graduates) dataset in order to estimate the impact of human capital on the self-employment status of individuals. To capture this effect, I use Probit and Logit techniques separately on men and women and find out that individuals who majored in medicine, law, business, architecture, psychology, fine arts and agricultural sciences are more likely to be self-employed. I do find evidence that women, Blacks and Hispanics have the smallest interest to run their own business. One important finding is that people with degrees in engineering, education and science choose mostly to be wage-employed.
The second essay examines the effect of human capital on self-employment earnings using the same dataset obtained for the first one. To estimate the coefficients on income levels, I take advantage of three different econometric methods, namely OLS, Heckit and matching estimator. Regression results on men show that having higher education brings more success in terms of self-employment earnings. Evidence shows that men do better when they are self-employed whereas women are better off when they are wage workers. The most lucrative majors for the male entrepreneurs are architecture, math, physics, chemistry and most fields of engineering. Women entrepreneurs who enjoy higher earnings are mostly majored in architecture, medicine, law, psychology and counseling. However, no particular education level is found to contribute to female entrepreneurial earnings. Being Asian or in the middle-age category increases the likelihood of having higher self-employment incomes. Marriage is found to considerably contribute to male entrepreneurial earnings whereas it adversely affects female self-employment income.
In the final essay, I look at the effect population density has on US local self-employment rates. The motivation is the existence of a huge variation of population densities and a considerable deviation of self-employment rates across US states and counties. My hypothesis, which stems from the theory of division of labor, is that self-employment rate declines with a greater fraction of the population. Data for this analysis are taken from Integrated Public Use Microdata Series (IPUMS) in year 2000. I employ Probit and Logit models as the empirical strategy, separately on men and women. Results show that a negative and statistically significant impact of population density is present for both sexes.
Hence, people who are located in less crowded areas are more likely to be self-employed. Considering the relatively low availability of good-matching jobs in smaller places, self-employment can be explained as a failure of the size of the market place. This effect is found to be larger for people like physicians and lawyers who are in more specialized occupations, indicating a greater negative impact of the size of the location on the self-employment status of people with higher skills.
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Karahan Piskin, Hatice, "Three essays on self-employment" (2006). Economics - Dissertations. 33.