SELF-EMPLOYMENT



Classification of someone as employed or self-employed depends on several factors, including degree of independence, the freedom to hire others to do the work taken on, the freedom to work for others, and the assumption of risks. Courts have held that the individual does not necessarily have to provide the equipment to do the job, as in the case of independent television and film mixers working on equipment owned by client production companies.

A worker's status as a self-employed worker can be reinforced by having multiple clients, being paid based on work done instead of on hours worked, or obtaining an employer identification number from the Internal Revenue Service (IRS) by filing form SS-4. Working under a business name also helps reinforce this status. For some self-employed workers, their business name is simply their own name. Stipulating in written contracts that either party can be dismissed on 30 days' notice helps differentiate self-employed workers from employees, who often cannot be fired at will. Printing invoices, business cards, and stationery also help identify a worker as being self-employed. In addition, employees have more statutory rights, benefits, and protections than self-employed workers, who must generally negotiate protections and obtain their own insurance, retirement plans, etc. In other words, self-employed workers typically do not receive fringe benefits or pay Social Security, Medicare, and income tax installments directly.

Variations of the term include "independent contractors," "free agents," "freelancers," "consultants," "sole proprietors," and, creatively, "soloists," "virtual employees," "corporate refugees," "corporate mutineers," "lone wolves," "lone rangers," and "lone eagles."

While agencies and organizations did not collect accurate and consistent statistics of employed versus self-employed workers until the Decennial Census in 1940, the data available from the late 19th century and the early 20th century suggest that a significant portion of the work force was self-employed. Furthermore, the systematic survey and classification of the self-employed in 1940 indicated that 10 million people were self-employed as unincorporated businesses largely performing agricultural, fishing, and forestry tasks. These 10 million self-employed workers accounted for about 20 percent of the work force in 1940. In contrast, there were still around 10 million self-employed workers in mid-1999 (10.1 million as of May 1999), but they accounted for only about 9 percent of the total work force. Moreover, the percentage of self-employed agricultural workers has plummeted: whereas self-employed agricultural workers represented 90 percent of the self-employed in 1940, they represented about 8 percent in 1999. Instead, service and executive/administrative occupations supplanted farming-related ones as the primary occupations of the self-employed, together accounting for almost 30 percent of all self-employed workers in the mid- to late 1990s, according to the U.S. Bureau of Labor Statistics (BLS).

Self-employment declined after World War II, dropping to under 7 percent of the labor pool by 1969, but it began to increase slowly by the mid-1970s. Self-employment received increased attention in the 1980s and 1990s as many large firms responded to the growth of competition and a lingering recession by "downsizing," or reducing the size of their "permanent" staffs and hiring temporary employees and contracting with self-employed workers to reduce overhead. Some such groups of businesses have been called "virtual corporations," as they perform functions formerly grouped under a single corporation, but legally do not exist under one ownership. While in the past a large company using freelancers seemed to imply a crisis, it became a commonplace way to control costs and try out new talent in the 1990s.

The increase in self-employment, moreover, can be attributed partially to workers' compensation, social security, and job protection laws, which have made employers cautious about hiring full-time employees. In addition, sometimes smaller companies only can afford to temporarily hire professionals who have had experience at larger, more sophisticated companies.

While self-employment has a number of benefits such as independence and job flexibility, it also has some drawbacks. Intermittent income is one of the most important difficulties the newly independent businessperson must face. Downtime can be avoided by overscheduling or moonlighting, working a salaried job, also. New business owners are advised not to rely on their enterprises for income for at least the first six months; comfortable returns may not follow for months afterward.

SELF-EMPLOYMENT DATA

One of the primary sources for statistics on self-employment in the United States is the monthly Current Population Survey (CPS). The CPS was launched in 1940 as part of an effort to determine monthly unemployment levels, because the Great Depression still affected the country at the time. This survey includes data on different classes of workers—as well as on other aspects of employment such as industry and occupation—which refers to the distinction between agricultural and nonagricultural workers and between wage and self-employed workers, in addition to other classes of workers not relevant here.

The CPS tracks whether people over the age of 16 are employed, unemployed (seeking employment), or not in the work force at all. Those who have jobs are then classified as employed by government, private companies, or nonprofit organizations, or as self-employed. Workers indicating they are employed by government, private companies, or non-profit organizations are classified as wage and salary workers, whereas workers indicating they are self-employed are classified as self-employed, if their business is not incorporated. If self-employed workers have incorporated businesses, they are classified as wage and salary workers, because they are technically employees of their own businesses according to the law. (Incorporation establishes a company as a legal entity—the corporation—which is permitted to enter into contracts and open bank accounts. A corporation also has tax advantages.) This method of questioning has largely been consistent since 1948, with the exception of the distinction between being self-employed and owning an incorporated business, which was adopted in 1967.

The BLS also has another relevant survey: the Contingent and Alternative Work Arrangements Supplement to the Current Population Survey. This survey is conducted every two years and it tracks self-employed workers classified as independent contractors. Respondents who indicated they were self-employed but not incorporated in CPS survey are asked if they are self-employed as independent contractors, independent consultants, or freelance workers.

TYPES OF SELF-EMPLOYMENT

The Bureau of Labor Statistics distinguishes between two types of self-employed workers: independent contractors and business owners who have not incorporated their businesses (as mentioned above, owners of incorporated businesses are not classified as self-employed according to BLS criteria). Independent contractors include workers who are self-employed on a contract basis. The contracts they receive contracts specify the type and amount of work they are to perform as well as work-related arrangements and legal issues. There are many different types of independent contractors: professionals leaving corporate life, youngsters delivering papers, single parents stuffing envelopes at home, and construction-related workers. Professional and white collar self-employment services include editing, developing and running training programs, writing, graphic design, consulting, and financial services.

On the other hand, self-employed business owners (e.g. family and home business owners) refer to operations that have not been incorporated, which generally have few employees. Self-employed business owners take the form of anything from restaurant owners to store owners. The overall number of self-employed workers in the United States in the late 1990s stood at about 10 million.

In general, male independent contractors tended to work as managers, construction workers, writers and artists, and real estate and insurance agents in the late 1990s, whereas female independent contractors tended to work as managers, writers and artists, real estate and insurance agents, salespeople, and childcare providers, according to the BLS. Overall, about 17 percent of self-employed workers performed executive, administrative, and managerial tasks during this period. These workers either ran their own businesses or were self-employed as accountants and other professionals. By 2006, the BLS expects the percentage of self-employed professionals to reach 18.7. Self-employed workers performing service-related tasks such as providing child care or home health care services accounted for 11.5 percent of all self-employed workers during this period and the percentage of self-employed service workers is forecast to reach 12.6 percent by 2006.

CHARACTERISTICS OF THE
SELF-EMPLOYED

Various personal characteristics seem to steer people into self-employment, such as being the oldest child or having parents who were self-employed. In addition, individuals are more likely to become self-employed if they have been fired from more than one job, have been previously employed in small businesses, are college graduates, are realistic risk takers, and are well-organized and good at organizing others. Furthermore, many are immigrants or children of immigrants. Some personality requirements for success as a self-employed worker are confidence, a positive outlook, friendliness, and the determination to succeed.

Self-employed individuals as a whole tend to work longer hours (an additional 4 hours per week, according to the Bureau of Labor Statistics) and work harder than their wage and salary counterparts—and they do it for irregular pay and, frequently, fewer benefits. About 26 percent of all independent contractors worked less than 35 hours a week, while 30 percent worked 49 hours a week in the late 1990s. The average work for all independent contracts was 46.3 hours. In addition, the income and assets of self-employed workers are dependent on their work contributions in a more intimate way than are those of their wage and salary counterparts. Not surprisingly, a study of certified public accountants in 1986 found the self-employed ones to have higher levels of organizational commitment.

In addition, self-employed workers who were independent contractors earned more on average than their wage and salary counterparts. For example, the BLS reported that independent contractors earned an average of $587 per week in 1997, whereas wage and salary workers averaged $510 per week. Studies concerning the amount of education of self-employed individuals point out that higher education generally may lead to higher pay. The BLS indicated that college graduate independent contractors averaged $752 per week, while high school graduate independent contractors averaged $512 per week. Independent contractors who did not graduate from high school averaged even less: $398 per week.

Furthermore, education also can play a key role in whether or not a worker is self-employed, although it depends to some extent on how being self-employed is defined. A common assumption has been that those with a higher level of education are more apt to be self-employed. Studies based on unincorporated self-employed workers have confirmed this belief to some extent by showing a moderate correlation between education level and self-employment. For example, a higher proportion of independent contractors have four years of college or more than wage and salary workers do, according to the Bureau of Labor Statistics. Approximately 34 percent of independent contractors between the age of 25 and 64—who make up about 50 percent all self-employed workers—had college degrees in the late 1990s, while 29 percent of their wage and salary counterparts had college degrees.

The self-employed have been found to report lower absences, which has been attributed not to superior health but the feeling of being indispensable. In fact, their jobs tend to be more physically and psychologically stressful due to the investments in energy the jobs demand. Yet certain stress factors are generally absent from self-employment—such as corporate meetings and employee discipline problems, although dealing with clients presents its own stress, such as rush orders and negotiations.

Age is a significant characteristic when examining self-employment trends. As workers get older, their chances of being self-employed increases. For example, 2.5 percent of workers 20-24 years old are self-employed, whereas 10.5 percent of workers 45-54 years old and 26 percent of workers 65 and over are self-employed, according to BLS statistics from the mid-1990s. The BLS attributes this trend to the greater prevalence of self-employment when older workers first entered the work force and to the inclination of older workers to launch post-retirement careers or second careers. Moreover, younger workers often lack the necessary skills and funds to become self-employed. Based on numbers, the largest group of self-employed workers is the group of workers 35-44 year old, which totals about 1.9 million. In addition, about 7 percent of working women are self-employed, whereas 10 percent of working men are self-employed.

SMALL BUSINESSES AND HOME
BUSINESSES

Small business ownership is a significant part self-employment, which accounts for about 50 percent of self-employed workers. As previously mentioned, the BLS does not classify such business owners who have incorporated their businesses as self-employed. A study of small businesses by Robert L. Aronson indicated that 31 percent of the small businesses in the retail industry employed no workers and 67 percent in the construction industry employed no workers, indicating a significant amount of self-employment among small businesses. The self-employed small business owner must make many management decisions, such as keeping precise accounting and tax records, projecting cash flow, and making purchasing decisions. More successful individuals can—and frequently must—hire another professional to take on some of these tasks, particularly accounting, but also sometimes filing, manufacturing, billing, maintaining databases, mailing brochures, or selling.

Self-employment is often associated with working at home. However, wage and salary workers also work at home under various arrangements with their employers, so this characteristic is not exclusive to self-employed workers. In 1997, managers and professionals accounted for the largest share of home-based self-employed workers—1.7 million workers—according to the BLS. Other leading fields of home-based self-employment that year included sales, service, and precision production. The service industry accounted for 2.1 million home-based workers, followed by construction workers with 726,000 and retail workers with 532,000.

The personal computer and communications technology have made working at home more feasible throughout the 1980s and 1990s. Mastering these technologies has become essential for those without staffs. Through cellular telephones and pagers, the self-employed professional can stay in touch with clients throughout the day. Fax machines and modems make business over a large geographic area feasible and help the one-person office get work out quickly. Computerized spreadsheet and database programs are necessary to deal with administrative tasks quickly and efficiently. In addition, on-line services and electronic bulletin boards made instantaneous local, cross-country, and international networking and research feasible. Consultants can also use their computers to "manufacture" or "distribute'" their work product. In most cases, they make their work process more efficient, as well. About 55 percent of all home-based self-employed workers used a computer for their work in 1997.

BECOMING SELF-EMPLOYED

Many articles and books on self-employment urge people to systematically plan their foray into self-employment, whether they intend to be independent contractors or business owners. The first step is developing a business plan, which includes determining individual interests, skills, strengths, weaknesses, and so on. This step also involves figuring out who the potential customs and competitors will be as well as researching the market for the intended line of business. In addition, part of planning for self-employment should include establishing contacts—potential clients—in the intended market.

Next, those preparing for self-employment must begin marketing themselves. One technique, while time-consuming and expensive, is making cold calls and using mailing lists to introduce services and skills. In addition, self-employed workers should emphasize their individual expertise, which marketers refer to as "unique selling propositions." Speaking at conventions and writing for trade journals on topics of professional competence are effective ways of going about emphasizing individual expertise. However, marketing is not only essential in the beginning but also throughout a career as a self-employed worker.

Self-employed workers also must set competitive fees. However, they often make the mistake of undercharging for their services or products at the beginning of their enterprises, at times even doing work for free with the hope of impressing new clients. This is partly due to a lack of confidence and partly because of their justified concerns about competing in the marketplace. This can pose a serious dilemma, as underpricing may not necessarily lead to more contracts; in fact, it can suggest a lack of quality. The best way of setting prices is finding out how much other self-employed workers in the same field are charging and basing fees on this information.

As they begin their enterprises, self-employed individuals feel compelled to accept a variety of assignments due to sheer scarcity of work. However, specialization can help ensure their long-term survival. For one thing, corporate clients can often find a generalist's abilities in-house. Also, specialization may allow professionals to broaden their client base geographically—freeing their fortunes from fluctuations in the local economy. These factors can enable the specialist to earn higher fees and work more consistently. Paradoxically, one's work as a specialist can garner referrals outside one's specialty, so specialization might not be as limiting as a strict definition would imply. The self-employed should be cautioned against changing their specialties too often, as this can confuse clients and make their own operations inefficient.

Depending on the line of business, self-employed workers may also have to obtain financing for supplies and equipment. Hence, research of various methods of financing may be necessary. Finally, being self-employed requires attention to administrative matters such as record keeping, accounting, insurance, and maintaining equipment.

TAX AND BENEFIT ISSUES IN SELF-
EMPLOYMENT

Self-employment has long been a focus of the Internal Revenue Service (IRS). The IRS estimated that the self-employed underpay about $20 billion a year in taxes. Independent contractors and sole proprietors generally must pay taxes on all business profits—sales over business expenses. These self-employed workers usually may deduct expenditures for work-related equipment such as computers, telephones, trucks, tools, and other such expenses. To reduce taxes owed, forming a subchapter S corporation is an option, particularly when income before expenses and taxes exceeds $150,000. In an S corporation, income is not subject to self-employment taxes.

Nevertheless, self-employment provides some tax advantages, such as retirement plans and home-office and transportation deductions. In the simplified employee pension plan (SEP-IRA), a maximum of 13.1435 percent of net income can be contributed to these accounts annually, up to $30,000. A portion of the home dedicated exclusively to business use may be depreciated over 31 1/2 years. A standard deduction, 30 cents per mile, may be used for business-related transportation costs, or actual fuel and maintenance costs. Also, up to 25 percent of medical insurance premiums may be deducted for sole proprietors, partners, and more-than-2 percent S corporation shareholders; also, the self-employed pay Federal Insurance Contributions Act (FICA) tax on net, not gross, earnings. For these reasons, it is essential to keep an accurate record of expenses.

However, there are other tax disadvantages for unincorporated businesses besides the ones mentioned above. For example, owners of such businesses are not able to fully deduct employee contributions to health insurance. Not surprisingly, this discourages the self-employed from getting health insurance for themselves and their employees. Health insurance may be available through one's prior employer. The Consolidated Omnibus Budget Reconciliation Act(COBRA) requires companies with more than 50 employees to offer health care coverage up to 18 months after an employee leaves; this may be the only option for people with preexisting conditions that preclude new insurance coverage. Under this plan, however, employees must pay 102 percent of their insurance premiums (including a two percent administrative fee). Under COBRA, the departing employee is also credited with deductibles already paid, while temporary plans reset deductibles. Other options include a spouse's company plan, a trade organization plan, or individual coverage.

Independent life insurance plans tend to give better coverage than company plans that are converted within 30 days of leaving a job. Disability coverage typically can't be converted, but it can be necessary to cover business overhead during an out-of-work period. A single-premium insurance policy, where only one premium payment is required, is one solution to the problem of pensions that irregular earnings creates.

SELF-EMPLOYMENT AND JOB GROWTH

While self-employment contributed the country's job growth in the 1980s, it appeared to have no appreciable effect in the 1990s, according to the BLS. Between 1989 and 1997, self-employment accounted for only 0.7 percent of employment growth in the United States. In contrast, it led to 79 percent of job growth in Canada, whose economy is linked to the United States', during this period. This contribution to overall job growth marks a substantial drop in influence of self-employment on U.S. job growth, because between 1979 and 1989 self-employment was responsible for over 13 percent of the country's job growth. During the same period, self-employment accounted for about 17 percent job growth in Canada.

SEE ALSO : Small Businesses

[ Frederick C. Ingram ]

FURTHER READING:

Bregger, John E. "Measuring Self-Employment in the United States." Monthly Labor Review, January-February 1996.

Cohany, Sharon R. "Workers in Alternative Employment Arrangements: A Second Look." Monthly Labor Review, November 1998.

Manser, Marilyn E., and Garnett Picot. "The Role of Self-Employment in U.S. and Canadian Job Growth." Monthly Labor Review, April 1999.

Smith, Brian R. How to Become Successfully Self-Employed. Holbrook: MA, 1997.



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