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Sole Proprietorship VS Self Employed: Is There A Difference?
6
Min Read
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.
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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.
What Defines a Verbal Contract?
A verbal contract (formally called an oral contract) refers to an agreement between two parties that's made —you guessed it— verbally.
Formal contracts, like those between an employee and an employer, are typically written down. However, some professional transactions take place based on verbally agreed terms.
Freelancers are a good example of this. Often, freelancers will take on projects having agreed on the terms and payment via the phone, or an email. Unfortunately, sometimes clients don't pull through on their agreements, and hardworking freelancers can find themselves out of pocket and wondering whether a legal battle is worth all the hassle.
The main differences between written and oral contracts are that the former is signed and documented, whereas the latter is solely attributed to verbal communication.
Verbal contracts are a bit of a gray area for most people unfamiliar with contract law —which is most of us, right?— due to the fact that there's no physical evidence to support the claims made by the implemented parties.
When is a Verbal Agreement Legally Binding?
For any contract (written or verbal) to be binding, there are four major elements which need to be in place. The crucial elements of a contract are as follows:
- Offer and acceptance: An offer is made and accepted by another party involved in the agreement;
- Consideration: The involved parties must exchange something of value (money, a service, time, etc), this is known as consideration;
- Intention and certainty: All parties must fully understand the terms of the contract and intend to make a legally binding agreement freely; and
- Capacity: The parties must have the capacity to legally enter into the contract; they're above age and of a stable mindset.
Therefore, an oral agreement has legal validity if all of these elements are present. However, verbal contracts can be difficult to enforce in a court of law. In the next section, we take a look at how oral agreements hold up in court.
How strong is a verbal agreement in court?
Most business professionals are wary of entering into contracts orally because they can difficult to enforce in the face of the law.
If an oral contract is brought in front of a court of law, there is increased risk of one party (or both!) lying about the initial terms of the agreement. This is problematic for the court, as there's no unbiased way to conclude the case; often, this will result in the case being disregarded. Moreover, it can be difficult to outline contract defects if it's not in writing.
That being said, there are plenty of situations where enforceable contracts do not need to be written or spoken, they're simply implied. For instance, when you buy milk from a store, you give something in exchange for something else and enter into an implied contract, in this case - money is exchanged for goods.
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get started nowWhen are verbal agreements not enforceable?
There are some types of contracts which must be in writing.
The Statute of Frauds is a legal statute which states that certain kinds of contracts must be executed in writing and signed by the parties involved. The Statute of Frauds has been adopted in almost all U.S states, and requires a written contract for the following purposes:
- The sale of real estate or vehicles
- Real estate leases lasting longer than one year.
- Property transfer following the death of the owner.
- The case of a party agreeing to pay debt for someone else.
- Any contract that requires more than a year to fulfil.
- A contract involving and exceeding a specified amount of money (which varies by state).
Typically, a court of law won't enforce an oral agreement in any of these circumstances under the statute. Instead, a written document is required to make the contract enforceable.
Contract law is generally doesn't favor contracts agreed upon verbally. A verbal agreement is difficult to prove, and can be used by those intent on committing fraud. For that reason, it's always best to put any agreements in writing and ensure all parties have fully understood and consented to signing.
How are Verbal Contracts Enforced?
Verbal agreements can be proven with actions in the absence of physical documentation. Any oral promise to provide the sale of goods or perform a service that you agreed to counts as a valid contract. So, when facing a court of law, what evidence can you provide to enforce a verbal agreement?
How can you prove an oral contract?
Unfortunately, without solid proof, it may be difficult to convince a court of the legality of an oral contract. Without witnesses to testify to the oral agreement taking place or other forms of evidence, oral contracts won't stand up in court. Instead, it becomes a matter of "he-said-she-said" - which legal professionals definitely don't have time for!
If you were to enter into a verbal contract, it's recommended to follow up with an email or a letter confirming the offer, the terms of the agreement , and payment conditions. The more you can document the elements of a contract, the better your chances of legally enforcing a oral contract.
Another option is to make a recording of the conversation where the agreement is verbalized. This can be used to support your claims in the absence of a written agreement. However, it's always best to gain the permission of the other involved parties before hitting record.
Written vs Verbal Contracts: What's the Verdict?
Fundamentally, most verbal agreements are legally valid as long as they meet all the requirements for a contract. However, if you were to go to court over one party not fulfilling the terms of the contract, proving that the interaction took place can be extremely taxing.
So, ultimately, the question is: written or verbal agreements?
Any good lawyer, contract law firm, or legal professional would advise you to make sure you formalize any professional agreement with a written agreement. Written contracts provide a secure testament to the conditions that were agreed and signed by the two parties involved. If it comes to it, a physical contract is much easier to eviden in legal circumstances.
Freelancers, in particular, should be aware of the extra security that digital contracts may provide. Many people choose to stick to executing contracts verbally because they're not sure how to write a contract, or they think writing out the contract terms is too complicated or requires expensive legal advice. However, this is no longer the case.
Say hello to digital contracts
Today, we have a world of resources available at our fingertips. The internet is a treasure trove of invaluable information, platforms, and software that simplifies our lives. Creating, signing, and sending contracts has never been easier. What's more, you don't have to rely on a hiring a lawyer to explain all that legal jargon anymore.
There are plenty of tools available online for freelancers to use for guidance when drafting digital contracts. Tools like Bonsai provide a range of customizable, vetted contract templates for all kinds of freelance professionals. No matter what industry you're operating in, Bonsai has a professional template to offer.
Benefits of written contracts
A written contract makes the agreement much easier to prove the terms of the agreement in case something were to go awry. The two parties involved can rest assured that they're legal rights are protected, and the terms of the contract are sufficiently documented. Plus, it provides both parties with peace of mind to focus on the tasks at hand.
Create Professional Contracts with Bonsai
Bonsai's product suite for freelancers allows users to make contracts from scratch, or using professional templates, and sign them using an online signature maker.
With Bonsai, you can streamline and automate all of the boring back-office tasks that come with being a freelancer. From creating proposals that clients can't say no to, to sealing the deal with a professional contract - Bonsai will revolutionize the way you do business as a freelancer.
Why not secure your business today and sign up for a free trial?
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