Self-employment refers to the status of an individual who—rather than accepting a position as an employee of another person or organization—chooses to go into business for him or herself. Self-employment offers individuals a number of advantages, from the freedom to work without supervision to the ability to deduct the costs of doing business for tax purposes. But it also has some potential drawbacks, including uncertain levels of income, long working hours, isolation, and the need to fund one's own health insurance and retirement plans. People choose self-employment for a wide variety of reasons. Some desire a change in lifestyle, some are unable to find other employment, some want to work at home in order to care for small children, and some are retirees seeking additional income. Regardless of the under-lying motivation, however, there are ways for self-employed persons to overcome the potential drawbacks and increase their chances for success.
Individuals who choose self-employment must be aware of the rules governing the treatment of free-lance employees (also known as independent contractors). Classification of someone as an employee or a self-employee is somewhat ambiguous and depends on several factors, including the 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. Independent contractors typically accept no fringe benefits and pay Social Security, Medicare, and income tax installments directly. Employees have more statutory rights, benefits, and protections than subcontractors, who must generally provide these for themselves. But independent contractors have advantages in terms of freedom, flexibility, and tax deductions.
The IRS applies a 20-part test in order to determine whether a certain worker should be classified as an employee or an independent contractor. The main issue underpinning the test is who sets the work rules: employees must follow rules set by their bosses, while independent contractors set their own rules. For example, an individual who sets his own hours, receives payment by the job, and divides his time between work for several different employers would probably be classified as an independent contractor. Other criteria involve who provides the tools and materials needed to complete the work. For example, an individual who works at an employer's facility and uses the employer's equipment would be considered an employee, while one who works at a separate location and provides her own equipment would be classified as an independent contractor. Finally, an independent contractor usually pays his own expenses of doing business and takes the risk of not receiving payment when work is not completed in accordance with a contract, while an employee is usually reimbursed for business-related expenses by the employer and receives a paycheck whether his work is completed or not.
An individual's status as a self-employed, independent contractor can be reinforced by having multiple clients, being paid by the amount of work done rather than by the hour, or obtaining an employer identification number from the IRS. Working under a business name also helps reinforce this status. Printing invoices, business cards, and stationery can also help identify someone as a self-employed person. In general, the person must demonstrate that he or she is in business for the purpose of making a profit.
The concept of self-employment received increased attention in the 1980s and early 1990s as many large firms responded to increased competition and a lingering recession by "downsizing," or reducing the size of their permanent staffs and hiring temporary employees and independent contractors to reduce overhead. The financial impact of workers' compensation, Social Security, and job protection laws also made employers more cautious about hiring full-time employees. While in the past a large company using free-lancers seemed to imply a crisis, it became a commonplace way to control costs and try out new talent in the 1990s. At the same time, many employees who were laid off chose to go into business for themselves rather than reenter an increasingly un-stable work force. The growth of self-employed professionals, in turn, enabled smaller companies to en-list the services of people who have had experience at larger, more sophisticated companies, without the cost of hiring them full-time.
Another factor influencing the growth of self-employment was that personal computer and communications technology 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. In addition, computer technology made instantaneous local, cross-country, and international networking and research feasible. The relatively low price of personal computers, peripherals, and communications equipment have enabled many more people to conduct business independently.
By 1993, one-fifth of all new jobs in the United States were created by self-employment, and self-employed persons accounted for 7.6 percent of the work force. In fact, job growth in this category increased almost twice as fast as overall job growth. The highest growth came in the finance, insurance, property, and business services industries—areas where professionals could expect to earn more by becoming independent. In the late 1990s, the number of self-employed Americans actually declined slightly as a percentage of the U.S. work force, and according to some studies, only 2 percent of people who go the entrepreneurial route stay self-employed 10 years later. But despite such sobering statistics, starting one's own business remains a dream that continues to be pursued by millions of individuals every year.
Self-employed individuals as a whole tend to work longer (an additional 17.5 hours per week, according to one study) and harder than their colleagues who are organizationally employed. Moreover, self-employed people often operate under uncertain payment schedules and must make outlays from personal earnings for insurance and retirement. In addition, their salaries and assets are dependent on their work contributions in a more intimate way than are those of their colleagues. The entrepreneurial role is also often more physically and psychologically stressful due to the investments in energy the jobs demand.
ISOLATION AND NETWORKING Isolation often proves to be an important source of psychological strain for self-employed individuals. The environment of the typical self-employed individual is quite different from the corporate environment where many professionals gain their experience. This is one reason contact with supportive colleagues becomes crucial. Mentors can provide advice regarding business aspects of a new business owner's operation. Trade and professional organizations can be an excellent way to establish contacts with peers. Tenacity in networking has been cited as a key to survival for business owners, some of whom maintain databases of thousands of contacts. These contacts are also vital in referring clients and providing market information. The role of the contact is made more important as the self-employed individual typically has no staff for marketing support.
It is difficult to exaggerate the importance of referrals to the typical independent professional. Since relationships are so vital, one must exercise the utmost delicacy in terminating employment with one's former employer or turning down a job. One's former employer can even become a good client, besides providing valuable referrals. When turning down clients, the self-employed person can protect those relationships by making referrals or even subcontracting to other colleagues in their network. Provided the work done is of quality, this can strengthen one's reputation as a purveyor of talent—whether one's own or an associate's. When the client calls back with a more appropriate assignment, the contractor has the choice of the business.
As they begin their enterprises, many 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, thus 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.
TAX IMPLICATIONS Self-employment entails both tax advantages and disadvantages. In terms of advantages, individuals who are classified as independent contractors can deduct work-related expenses for tax purposes. In addition, independent contractors often qualify for tax deductions for using part of their home as an office and for salaries paid to other people, while employees usually do not. Independent contractors also can claim significant deductions for medical insurance, transportation, office supplies, and a host of other operating costs.
The main tax disadvantage for self-employed persons is that they must pay the full amount of Social Security and Medicare taxes themselves and make quarterly estimated tax payments to the federal government. For those who are organizationally employed, the employer withholds income taxes and pays half of their Social Security and Medicare taxes. Although the payment of Social Security and Medicare increases the tax burden of self-employed individuals, these amounts are based on net, rather than gross, earnings. For this reason, it is essential for small business owners to keep an accurate record of expenses. Self-employed individuals also file quarterly taxes.
Self-employment, whether by choice or necessity, does not include any guarantee of success. In fact, nearly two out of every three new businesses fail within five years. But the chances of success can be greatly improved with careful planning, prior savings, and a sound marketing strategy. It may also be helpful to make the transition to full-time self-employment gradually. One option is to "moonlight," or work part-time as a free-lancer while maintaining at least part-time employment on the side. Although some employers frown on this arrangement, it can provide an individual with time and money to develop a client base and a business plan. Those planning home-based businesses should also take time to prepare family members for the changes that will take place.
Some prospective new business owners also try to establish one stable client relationship that will provide steady income during the search for additional clients. A particularly attractive option may be an individual's former employer, which will already be familiar with the would-be entrepreneur's reputation and abilities. For this relationship to succeed, however, it is important that the individual use an honest and professional approach when severing ties with their employer. Of course, your employer may not react warmly to such an arrangement if your new business is a potential threat to its own financial fortunes.
Although one stable client relationship can help establish a new business, it is also important that the self-employed person develop a marketing strategy to find new clients and grow. Many new business owners become so busy serving their existing clients that they do not devote sufficient time to marketing. Sending out brochures, networking, and joining professional organizations are a few possible marketing strategies.
Finally, self-employed individuals should take an organized approach to all business activities in order to increase their chances of success. It may be helpful to draw up a business plan to follow when starting and growing a new business. This plan can help a self-employed person evaluate strategies, plan expenditures, and motivate him or herself. It is also important to keep careful records of income and expenses, set aside money for taxes, and insist upon contracts for all work performed.
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