These days, many people are taking the plunge into self-employment and becoming business owners. While the debate around self-employed vs business owner might seem like splitting hairs, running a small business, being an entrepreneur, and working for yourself all have distinct differences.
All scenarios offer independence and the chance to be your own boss, but they come with unique differences in terms of responsibilities, taxes, and legal structures. Let’s break down these roles to help you identify where you fit and what to expect.
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What is the difference between a self-employed person and a business owner?
A self-employed person works for themselves and is responsible for managing their own business, setting their own hours, and determining their pay. Freelancers, independent contractors, and sole proprietors typically fall under this category. Legally, a self-employed person can operate as a sole proprietorship or an independent contractor.
A small business owner, on the other hand, owns and operates a business with a small number of employees. They can choose to structure their business as a sole proprietorship, partnership, LLC (Limited Liability Company), or corporation.
Is a business owner the same as an entrepreneur?
Another common misunderstanding is the difference between business owner vs entrepreneur. Let's clear this up:
Entrepreneurs are individuals who launch new businesses with the goal of expansion and innovation. Different from an entrepreneur, a small business owner may not prioritize rapid growth or expansion. Entrepreneurs often earn their income from investments or venture capital, whereas a self-employed person or a small business owner typically relies directly on revenue from their clientele.
In essence, every entrepreneur is a business owner, but not all small business owners are entrepreneurs.
What is the difference between a freelancer and a business owner?
Freelancers are a prime example of self-employed individuals. They usually offer specific services, such as writing, graphic design, or consulting, often working with multiple clients simultaneously.
Freelancers manage their projects and time independently on a contract basis. Business owners, while they can also be service providers, typically manage a broader operation. They might employ freelancers or contractors, manage product development, and focus on business growth strategies.
Self-employed vs business owner: Identify which category you fall into
Think about how formally you've established your occupation. Self-employed individuals operate informally, while small business owners establish a corporation or LLC, offering more protection and growth potential.
If you work independently, providing services directly without a team of full-time employees, you are likely self-employed. Business owners run a more structured operation. If you're actively seeking growth and profit to have full-time employees, you would fall under the entrepreneur or small business owner category.
Taxes, salary, and benefits for self-employed individuals and small business owners
Understanding each category is a good starting point, but the real differences come down to the administrative side of things. From a legal and financial perspective, the distinctions between self-employed individuals and small business owners boil down to how their activities are structured and managed.
Starting a company involves a more structured process, including registering your business at both the state and federal levels. In contrast, a self-employed person can operate using just their Social Security number.
Let's go over the main differences in taxes, salary, and benefits.
Self-employed vs business owner: Taxes differences
“Self-employed individuals report business income on their personal tax return and pay self-employment tax,” says John Pace, a tax manager at Pace & Associates CPAs with over 40 years of experience. “Small business owners file separate business tax returns and can take advantage of deductions and benefits unavailable to the self-employed, like certain retirement plans.”
The tax obligations for small business owners can vary based on their business structure. For example, LLCs and corporations might benefit from more tax deductions and could pay corporate taxes instead of self-employment taxes. Small business owners may also draw a salary, which affects how their taxes are calculated and paid.
Self-employed individuals, on the other hand, must pay self-employment tax, covering Social Security and Medicare. This tax is currently 15.3% of their net earnings, which can be a significant expense. They also need to track their income and expenses to file a Schedule C with their personal tax return.
Self-employed vs business owner: Salary differences
Self-employed individuals earn directly from their services. Their income can fluctuate based on client availability and workload. There are no fixed salaries, and earnings are typically subject to personal income tax rates.
Small business owners can draw a salary from their business, which provides more stability in income. They can also reinvest profits back into the business or distribute earnings through dividends, depending on the business structure. This can offer more financial flexibility and planning opportunities.
Self-employed vs business owner: Differences in benefits
Self-employed people might not be able to receive benefits that are typically provided to employees, including paid time off or health insurance. Small business owners have more freedom to design their own benefits plan for both themselves and their staff.
For self-employed individuals, paying self-employment tax, which includes contributions to Social Security and Medicare, allows them to earn credits towards receiving benefits from these programs in the future.
As for small business owners with employees, it's their responsibility to withhold and match their employees' contributions to Social Security and Medicare. They may also have additional obligations depending on the size and structure of their business.
Bottom line
Overall, if you’re aiming to be your own boss, it’s key to understand the legal and financial aspects of your role so you can handle taxes and benefits effectively. It might be worth talking to a legal and financial expert to figure out what’s best for your situation.
Whether you're self-employed or a small business owner, you should be aware of your tax responsibilities and potential benefits such as Social Security and Medicare contributions.
By understanding these differences and taking appropriate actions, you can better manage your career and personal finances.