Self Employed vs Small Business: Learning the Key Differences

The main difference between self-employed vs. small business owners lies in the key operations of the business. The former refers to someone who works alone and handles all aspects of their business on their own, while the latter refers to someone who operates and oversees both the company and its employees.

While this may seem like a minor difference, it can significantly change a person’s involvement in the day-to-day operations of the business and how they earn an income and file their taxes.

In today’s article, we’ll dive into the key differences between self-employed vs. small business owners and discuss the pros and cons of each one. Let’s start!

Key Takeaways

• Self-employment is the state of working for oneself and can be categorized as an independent contractor, proprietorship, or partnership. While this type of employment offers great work freedom and tax deductions, it has an unstable income and no employee benefits.

• Small business ownership is the state of owning and managing a small business. It offers better earning potential and less personal liability than self-employment but can be more expensive to manage.

• Income reporting for self-employed vs. small business owners can involve bank statements, profit and loss statements, pay stubs, and invoices.

• The tax obligations for self-employed vs. small business owners vary, with the former concerned with self-employment and annual income taxes and the latter requiring payroll, employment, and excise taxes, to name a few.

• Payroll processing is a key part of small business ownership but isn’t required for self-employment.

What is Self-Employment?

Self-employment means working independently or running your own business rather than for an employer. That said, it’s also possible to be self-employed without a business, as according to the IRS, self-employment applies to any person who provides a service to other businesses.

While often confused with freelancing, a type of employment that involves working with companies on a contractual basis, self-employment is more than just being hired for a project. In fact, it’s more similar to owning a small business and offers flexibility and control over the work being done.

That said, freelancers are a type of self-employed individual and fall under one of the three categories we’ll explain next.

3 Main Types of Self-Employment

There are three main types of self-employment, namely:

• Independent contractor. This refers to individuals who provide a specific service, such as photographers, doctors, and freelancers, without being affiliated with the company. Since independent contractors handle the entire cost of their business operation, they are often subject to several tax deductions that can help ease this burden.

• Sole proprietorship. The most popular type of self-employment, sole proprietorship, refers to a business owned and operated by a lone individual without a separate legal entity. This means that the owner will be personally liable for all the business's losses, liabilities, and debts. And, unlike traditional employment, where workers are paid a fixed income, the sole proprietor payroll relies on company profits.

• Partnership. Lastly, a partnership refers to a business owned by two or more people. This type of self-employment functions similarly to sole proprietorship, with the only difference being that liability and profits are shared between the owners.

Benefits & Disadvantages of Being Self-Employed

Being self-employed vs. a small business owner both entails certain benefits and disadvantages with which you should familiarize yourself.

3 Key Benefits of Being Self-Employed

Some of the key benefits of being self-employed vs. a small business owner include:

• Great tax deductions. Self-employed individuals benefit from several tax deductions, such as home office, health insurance, and educational expenses. However, strict rules exist to be eligible for these deductibles. For instance, the IRS Publication 587, Business Use of Your Home, states that to qualify for this tax deduction, an individual must use a part of their home exclusively and regularly for business.

• Work flexibility. Being self-employed means that you can have as much flexibility in the clients and projects you work on. You also have more freedom over how much effort you put into the business. Since you are liable only for yourself, you can stop working at any time without affecting anyone else.

• Inexpensive management costs. With no employees to pay or property to rent, self-employment incurs very little to no management costs.

3 Crucial Disadvantages of Being Self-Employed

Despite its benefits, there are also some disadvantages to being self-employed vs. a small business owner or employee, such as:

• Unstable income. Having an unstable income during the first few months of self-employment is common, especially if you have not built up a solid list of clients yet. Unlike regular company employees, you can’t rely on a steady monthly paycheck for income. Another reason why a self-employed vs. small business owner's salary can also be significantly lower is that it depends on how much work you do in a month.

• No employee benefits. A big disadvantage of being self-employed vs. an employee is the lack of fringe benefits, such as paid leave and health insurance, often provided by the company. You would have to shoulder these costs on top of the expenses of running a business.

• More hands-on work. Since you will be taking on all the roles in the company, you can expect to do more hands-on work to keep it afloat and profitable. This means handling all the business's marketing, finance, and customer relations aspects while providing its main service.

What is Small Business Ownership?

Small business ownership, as the name suggests, refers to the act of owning and managing a small business. According to the U.S. Small Business Administration, a small business is a company with fewer than 500 employees. Additionally, as of 2023, there are more than 33 million small businesses in the U.S., making it the country's most common type of business structure.

But what makes small business ownership different from self-employment?

Self-employed individuals operate independently and handle all aspects of the business, from the work to its operation. Meanwhile, a small business owner is more concerned with overseeing the entire company and hires employees to do the actual work.

Main Types of Small Business Ownership

Like with self-employment, small business ownership can be in the form of a sole proprietorship or a general partnership.

In addition to these two, the main types of small business ownership can include:

• Limited partnership (LP). While similar to a general partnership, a limited partnership means that you have little to no involvement in the business operations and simply provide its funding.

• Limited liability company (LLC). In a limited liability company, the business owners won’t be personally liable for any business transactions, ensuring complete protection for their individual assets. In an LLC, the owner can file their taxes under personal or corporate tax.

• C corporation. Similar to an LLC, a C corporation is a business structure where the owners are considered a separate legal entity but would need to file their business taxes at corporate levels. C corporations can also be taxed twice, once on the company’s profits and once on the owners’ dividends.

• S corporation. Unlike C corporations, an S corporation can only be taxed once but has much stricter ownership limitations, with a maximum of 100 owners who must be U.S. residents. In an S corporation, the owners can file taxes under their personal tax.

Benefits & Disadvantages of Being a Small Business Owner

As a small business owner, you’ll have to be responsible for your employees’ pay, taxes, and insurance. Aside from that, there are several benefits and disadvantages to small business ownership you should be aware of.

Let’s discuss them in detail:

3 Vital Benefits of Being a Small Business Owner

If you decide on being a small business owner vs. self-employed, you can experience the following benefits:

• Better earning potential. Since business growth potential is limitless, if the company is successful, you will be able to earn significantly more than you would working as a self-employed individual.

• Ability to delegate tasks. As a small business owner, you won’t have to handle all the tasks involved in the day-to-day operations and can simply delegate tasks to improve efficiency and lessen workload.

• Less personal liability. Unlike self-employment, small business ownership means that the company is not your personal liability but rather a separate legal entity. This means that in case the business fails or becomes debt-ridden, your individual assets won’t be affected.

3 Important Disadvantages of Being a Small Business Owner

That said, there are also certain disadvantages to being a small business owner vs. self-employed, such as:

• More stress. In small business ownership, your employees rely on you to keep the business stable and successful. Because you are responsible for other people, this can be more stressful than self-employment.

• Longer work hours. Despite having fewer hands-on tasks, small business owners may end up with longer working hours since they have to oversee operations, tally the profits for the day, and finish other managerial tasks.

• More expensive to manage. Another downside of being a small business owner vs. self-employed is that you have more financial burden. In addition to the initial investment in the business, you have to constantly spend on employee expenses and overhead costs.
  

Self-Employed vs. Small Business: Income Reporting

Income reporting between self-employed vs. small business owners can vary, especially since their sources of funds differ.

Proof of income for self-employed individuals can come from their bank statements, annual tax returns, or profit and loss statements. Meanwhile, small business owners often need to report their income through financial statements and an IRS Schedule C (Form 1040) filing.

Alternatively, being a freelancer vs. a business owner means that you can create paystubs using an online paystub generator like Paystubs.org to report your income and simplify how you keep track of your finances. You can also use this tool to generate self-employed invoices to record the services and hours rendered for each project accurately.

Self-Employed vs. Small Business: Tax Obligations

Being self-employed vs. a small business owner means you are subject to self-employment taxes, which refer to Social Security and Medicare. According to the IRS, the self-employment tax rate is 15.3% of your net earnings. Self-employed individuals must also file an annual income tax return and make quarterly estimated tax payments.

On the other hand, small business owners may be subject to different types of business taxes, including income tax and estimated tax, depending on the nature of the business. Other tax obligations you may have include employment taxes and excise tax. Additionally, you will be responsible for payroll taxes and generating Form W-2 for employees.

A business owner may also need to file different small business 1099 forms once they hire independent contractors or earn from dividends, interests, and other miscellaneous sources.

Fortunately, you can use an online paystub generator like Paystub.org to generate the financial documents you need quickly, including pay stubs, W-2 forms, and 1099-MISC forms, for tax and income reporting.

Self-Employed vs. Small Business: Payroll Processing

When it comes to payroll processing, being self-employed vs. a small business owner absolves you from any obligation since you are the sole worker. Instead of receiving your income from a paycheck, you can directly get it from the business profits. You also don’t have to manage any W-2s or payroll taxes.

Meanwhile, small business owners are required to process payroll for their employees. Aside from paying an income, you must also calculate their state, local, and federal income taxes. You can also pay yourself as a business owner this way instead of withdrawing money directly from the business’s revenue.

Self-Employed vs. Small Business: How to Choose Which Is Right For You?

When trying to decide between being self-employed vs. a small business owner, here are some crucial factors you should consider:

• Personal liability. Being self-employed vs. an entrepreneur or business owner means you’ll have more personal liability in the company, which will make you responsible for all the business’ profits and losses. However, this also means that your individual assets won’t be protected and can be used if the business incurs legal issues.

• Amount of workload. Self-employed vs. small business owners can have varying workloads; the former works independently and handles every aspect of the business, while the latter involves more task delegation and employee management.

• Financial risk. Self-employment has a lower financial risk because there are minimal overhead costs involved, but this also means that it will have a lower earning potential. Meanwhile, small business ownership will have higher financial risks along with higher returns and profits.

Final Thoughts

Being self-employed vs. a small business owner can seem similar on the surface, but these two types of employment are fundamentally different and require varying levels of involvement. Self-employed individuals tend to work independently and have more personal liability in the business, while small business owners can limit their personal liability.

Regardless of which option you choose, it’s important to understand the income, taxes, and payroll obligations that the position entails. This will make it easier to monitor your financial status and allow you to make actionable decisions to keep your business profitable.