Sole Proprietorship vs Self-employed - Differences, Taxes, More

Sole proprietorship vs self-employed, what's the difference? You can be unsure if you are a single owner or an independent contractor if you are self-employed. Both of these business forms enable an individual to operate autonomously, but the operator can be taxed differently. The structure and operation of your company can also dictate whether you are a single owner or an independent contractor.

If you are self-employed, you have many alternatives for the legal entity with which you will register – you can be:

• Self-employed.
• Limited Liability Company for a Sole Proprietor (LLC).
• S Corporation.
• A constituent of a partnership.

Independent contractors and sole proprietors are frequently confused since they both fall under the category of self-employed company owners.

However, there are a few points to consider before making a choice between these two companies – the most significant distinction being their tax obligations and connection with clients.

What is a sole proprietor?

A sole proprietor is a person who owns and conducts a business on his or her own. A sole proprietorship is an unincorporated business form that is owned and operated by one person. If you operate a sole proprietorship, you are personally accountable for the debts and legal responsibilities of your company. Each year, you pay taxes on your company revenue on your personal tax return, however, you will also submit an IRS Form 1040 Schedule C outlining your business income and costs. Individuals who anticipate paying at least $1,000 in income tax are required to file estimated taxes.

Because they own and operate their own company, a lone proprietor is self-employed. When you work for yourself, you are not hired by an employer who provides a constant wage or salary, but rather makes money by contracting with and delivering goods or services to a variety of clients. Additionally, sole owners are responsible for self-employment taxes, which include Social Security and Medicare. Self-employment taxes are estimated to be roughly 15.3% of your net income.

A sole proprietorship is the usual business structure for a small company. To operate as a sole proprietorship, you are not required to register your company with the state or federal government, get a business license, or secure your business name. When you establish a business and separate your company's revenue and costs from your personal income and expenses, you have effectively established a single proprietorship and are now called a lone proprietor.

What is an independent contractor (self-employed)?

Additionally, independent contractors are self-employed persons who supply services to individuals and businesses but are not employees. An independent contractor is compensated for the service they provide. They can be compensated hourly or on a project-by-project basis, depending on the conditions of their contract. Employers of independent contractors do not deduct payroll taxes from their wages unless the contractors are subject to backup withholding. In many cases, independent contractors work in creative and technical sectors such as web development, content production, graphic design, and information technology.

A self-employed individual can also be referred to as a 1099 employee, referring to the tax form issued at the end of the year. Contractors who earn at least $600 from a client or company will receive a 1099-MISC form detailing their entire revenue for the calendar year. Individuals who work for several clients will obtain multiple 1099-MISC forms. Each form's revenue would be reported on the contractor's tax return, and any self-employment taxes would be deducted from those forms.

The IRS replaced the 1099-MISC form with the 1099-NEC form for the 2020/2021 tax year. This is the form that will be used in the future to record non-employee remuneration. Businesses and clients that hire independent contractors must submit these papers by January 31 to allow the contractor sufficient time to prepare and file their taxes.

Sole proprietor vs. independent contractor

Sole proprietors and independent contractors are both non-employee self-employed persons. Rather than that, they give services or commodities to clients on an individual basis and are not compensated for their job.

Both classes are comparable in that those who fulfill both roles:

• Separate business and personal expenditures
• Taxes on self-employment income
• Prepare your income taxes using a Schedule C form.
• Individuals who work for themselves rather than for an employer

The primary distinction between a single owner and an independent contractor is the method of reporting remuneration. While a single proprietor is responsible for tracking their own company costs, an independent contractor will get a 1099 form detailing their earnings over the previous calendar year.

However, depending on the nature of the services given, a single proprietor can obtain a 1099 form from their client.

Common questions about sole proprietors and independent contractors

When you establish your own business or perform contract services, you can have concerns regarding the setup process or how to handle certain scenarios that emerge. Both independent contractors and sole entrepreneurs are responsible for their own tax obligations, expenditure tracking, and resolution of any issues that arise, as they lack a human resources department or supervisor to consult. Consider the following commonly asked questions concerning sole proprietorships, independent contractors, and self-employment.

Can I be a self-employed sole proprietor?

Yes, because they do not have an employer or work as an employee, a single owner is self-employed. Having your own business and operating it qualifies you as a self-employed business owner.

What is the difference between an independent contractor and a single proprietor?

Depending on the sort of job they perform and how they are compensated, an independent contractor can be a single proprietor. Certain independent contractors work concurrently for numerous clients, delivering services on a freelance basis. Others perform independent contracting work in addition to full- or part-time employment. A sole proprietor is a sole owner and operator of a business; therefore, if this describes you, you can use this commercial phrase to refer to yourself.

How is a sole proprietorship different from other business structures?

A sole proprietorship is the simplest and least expensive business form to establish, as it does not need you to register with the government or the Internal Revenue Service. However, it does not function independently of you, the business's owner, which means you are personally liable for the business's legal responsibilities or debts. Various other company structures include the following:

LLC

An LLC provides the business owner(s) with personal liability protection comparable to that of a corporation, but with pass-through taxes. This kind of taxation applies to business revenue that is passed via the business to the owner, who declares it on their individual tax return.

Partnerships

Partnerships are a type of business arrangement in which two or more people jointly own and/or run the enterprise. Partnerships are further classified according to their organizational structure, with general partnerships, limited liability partnerships, and limited partnerships being the most common.

Corporations

A corporation is a type of company structure that gives the highest level of personal liability protection and is subject to more severe tax rules. Corporations are further classified into two types of tax entities: C-corporations and S-corporations.

Do I have to register my sole proprietorship as a legal entity?

By and large, sole proprietorships are exempt from registration as legal business organizations. Unless you supply regulated services or commodities, you are not needed to get a business license or register the business name with your local government office. For instance, physicians who perform services as independent contractors must be licensed to do so.

However, some sole owners take these precautions to safeguard their companies in the event that another sole proprietor or company owner attempts to start a company with the same name. Registering your company, obtaining a license, and opening a business bank account can also help lenders and investors assess your business's credibility.

Should I use a written agreement?

Independent contractors are advised to get into formal agreements with their clients describing the services supplied, the cost for those services, and the timetable for those services. A formal independent contractor agreement can also help identify your relationship as one between a hiring business and an independent contractor, rather than as one between an employer and an employee.

Do I have to pay self-employment tax as a sole proprietor?

Yes. Business expenses can still apply. And will go through your personal income rather than a business entity and business income and expenses. You'll be required to pay self-employment taxes on all income you've received.