Sole Proprietorship VS Self Employed: Is There A Difference?

6

Min Read

Tom Smery

Many people get confused between a sole proprietorship vs self-employed folks. Let me start off by saying a self-employed worker and sole proprietorships are one and the same. Since a sole proprietor operates a business on its own, they are considered self-employed.

A self-employed individual simply means the person works for him or herself. It's just a business term. A sole proprietor refers to someone who owns a business by themselves.

A sole proprietor does not work for a company like a traditional employee. Instead, of getting a consistent hourly wage or salary, a sole proprietor would earn income by contracting our services or goods to various clients or businesses. Both independent contractors and sole proprietors are self-employed people.

In this article, we'll go over what it means to be a self-employed sole proprietor.

Note: If you are a sole proprietor or independent contractor who needs help with invoicing, contracts, tax filing, and proposals, try Bonsai. Our all-in-one freelancer software can take the pain away from running your professional business. See for yourself how much time you can save by trying a 14-day free trial today.

Are Sole Proprietors The Same As Owning A Small Business?

The Small Business Administration determines a sole proprietorship is an unincorporated business owned and run by a single individual (a one-person business). There is no difference between the business and its owner. Since the business entity and the independent contractor are the same, the sole proprietor will be held accountable for all of the business's losses, debts, and liabilities.

A small business owner, on the other hand, is typically characterized to have a team of employees or hire independent contractors to run their business. A sole proprietor can generally be defined as a small business.

Again, a sole proprietorship offers no asset protection. Since the business entity is not separate from the person,  business assets are considered personal assets and vice versa.

You don't file for a charter with your state, and thus there is no separate corporate legal identity.

Limited Liability Protection

Many firms, particularly freelance and consulting organizations, begin as self-employed individuals who grow into small business owners or change their business structure as they grow. A LLC or limited liability company is a common structure for small businesses for financial protection. There are different personal financial risks and legal obligations when it comes to a small business owner with a formal business structure.  

An LLC is like a hybrid of a sole proprietorship and a corporation. In regards to tax purposes, it can

It is typically recommended to start an LLC or legal entity as soon as possible when you start your own business.

Independent contractors may be registered as a business entity but the majority are sole proprietors.

Examples of self-employed folks who are considered independent contractors by the IRS are graphic designers, writers, therapists, accountants, chiropractors, and artists. An independent contractor can work for several companies at the same time on a contract basis.

Depending on how much control the individual has in their job, they may be considered an independent contractor for tax purposes. Fro example, if you are an employee, your payer will instruct you with how to do your work or accomplish the expected results.

Sole Proprietors/Independent Contractors Need To Pay Self-Employment Taxes On Their Business Income

Self-employed people do not have their income withheld from their paycheck for taxes by an employer. Although contractors and sole business owners pay themselves, they must still pay Social Security and Medicare taxes on their income

As a self-employed business owner, you'll be required to estimate, deduct, and pay self-employment taxes as well as payroll taxes on the income you earn. Self-employment tax (Social Security and Medicare taxes) make up 15.3%. As a sole proprietor, you'll report your business tax on a Form 1040/1040-DR or Schedule C of your tax return. The net income from your Schedule C will be reported on your personal tax return.

When Will You Be Responsible For Income Taxes

Self-employment tax is applied to business income above $400 at the end of the year.  At the end of the year, an independent contractor will only receive a 1099 form for non-employee compensation if they were paid over $600 in self-employment or other income. The 1099 form will have the total income paid from clients or companies for whom the contractor provided services for. The form will be used to calculate your business's income tax return. All income earned from business activities needs to be reported to the IRS.

Although you may not meet the $600 minimum to receive a 1099 form, you may still have to pay taxes on your income.

You can calculate your self-employment taxes for the year with our free online calculator.

Note; If you are looking for a sure-fire way to manage your sole proprietor taxes, then try Bonsai Tax. Our tax software can help you estimate your taxes, send you filing reminders, and track all your tax deductions. In fact, the majority of users save $5,600 from their tax bill. Try a 14-day free trial today.

Breakdown Of Being A Sole Proprietor In Comparison To Other Business Structures

There are many differences a sole proprietor or independent contractor has compared to the other business structures. Let's review a few of them.

It's The Easiest To Get Started

The main benefit of a sole proprietorship is that it is fairly simple to start. A sole proprietor or independent contractor does not have to register as a small business within the State or federal government. Depending on your city or county, you may need a license to operate under a fictitious name.

if you want to use a fictitious business name, also called a DBA (doing business as), it is fairly easy to set up.

A sole proprietor is not a legal entity like an LLC or corporation. Instead, the person and the business are the same. As the solo business owner, you will be personally responsible for all the business debts, and personal finances.

Upgrading to a small business structure will mean you'll have max personal liability protection. Your business expenses, liability/debt would be separate from your personal life. As you grow your business and hire employees, an LLC can even safeguard your assets from litigation filed by dissatisfied ex-workers if your company starts recruiting more employees than independent contractors.

In summary, there are fewer requirements for business taxes, fewer registration fees,  easy banking, and simplified business ownership.

Simplified Taxes

As a sole proprietor, you'll need to stay up to date with all your tax requirements. Luckily, filing taxes is fairly easy for an independent contractor or sole proprietor. You do not need to file separate taxes for your business. You can simply report all of your business income and losses on your personal income tax return.

However, the personal obligation for legal judgments, taxes, and debts comes with that simplicity.

When you run your sole proprietor business, record your business expenses/income separate from personal expenses. We'll quickly review some common tax deductions you can claim to lower your tax liability.

Write-off Business Expenses

Sole proprietors can still deduct expenses like office supplies, business structure costs, advertising costs, business meals, travel expenses, and more by using a Schedule C.

So tracking your expenses for tax purposes is helpful. If you are an independent contractor or sole proprietor who needs help with expense tracking, try Bonsai Tax. Our freelancer tax software scans your bank/credit card receipts to discover tax write-offs automatically. In fact, the majority of users save $5,600 from their tax bill when they file taxes. Try a 14-day free trial today.

Control Over Your Business

Over the course of the business, the lone proprietor has entire control and decision-making authority. You are the single owner of the company without any partners, and you can operate it however you like.  

Tom Smery
Tom Smery is a certified CPA for over a decade. In his free time, he writes articles to pass on his expert knowledge on taxes and accounting. Thomas has a wide range of deep knowledge on 1099 taxes, and finance topics. You can find him fishing when he is not preparing taxes for his clients or writing about accounting.

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