Sole Proprietor Vs. Self-Employed – What’s The Difference?
When most people think of working for themselves, there are many confusing definitions of what this means. In the United States, there are over 27.1 million sole proprietors (IRS) and close to 10 million self-employed people (U.S. Bureau of Labor Statistics).
In many cases, the terms sole proprietor, self-employed, and independent contractor mean the same thing, but there are some distinctions. In this article, we will define each of these and try to make them easier to understand.
What is self-employment?
There are a lot of definitions for self-employed, however, a good one is from Merriam-Webster. They define self-employment as:
So, being self-employed means someone receives income from work that is not provided by an employer. As a self-employed person, you provide products or services for other people or businesses.
Self-employment covers a wide range of workers, including freelancers, graphic designers, photographers, writers, hair stylists, entertainers, and others.
What is an independent contractor?
Investopedia provides a definition for an independent contractor.
From this definition, the term self-employed and independent contractor are the essentially same. The one small difference is that an independent contractor is typically contracted to perform a job, while someone self-employed may or may not do contracted jobs.
An independent contractor is always self-employed, while someone self-employed could be, not don’t have to be considered an independent contractor.
What is a sole proprietor?
Before defining a sole proprietor, it’s worth mentioning that there are four main types of business entities. A business entity (also referred to as a legal entity) refers to how a business is organized to conduct business. The types of business entities include the sole proprietorship, general partnership, corporation, or Limited Liability Company (LLC).
A sole proprietor is someone who owns an unincorporated business. Owning an unincorporated business means the owner is solely responsible for all aspects of the business, from its profits to its debts and liabilities, taxes, etc.
A single-owner business can’t be a general partnership, as they require two or more owners.
Entities such as the LLC and corporation (that can be owned by one person) are separate entities that provide liability protection for the owner’s personal assets. The sole proprietor’s personal assets and business assets are considered the same legally and would be used to pay any business debts or lawsuits against the business.
At the end of the year, a sole proprietor will file IRS Schedule C with the IRS to report their business income and business expenses on the owner’s personal tax return. Any profits will be subject to personal income tax in addition to self-employment taxes, which is a combination of Social Security and Medicare taxes.
Related: Learn more about the LLC
What is the difference between a sole proprietor and self-employed?
In most cases, the terms are synonymous, however the difference between someone who is self-employed and a sole proprietor more related to the legal structure of their operation.
Someone who is a self-employed person can choose to be incorporated or establish an LLC, although most will operate as a sole proprietorship.
So, a sole proprietor is a self-employed individual, but a self-employed individual is not necessarily a sole proprietor.
What is the difference between a sole proprietor and an independent contractor?
The terms sole proprietor and independent contractor are very similar, with one main distinction. Independent contractors will work for another company for a set fee, while sole proprietors could also work as a contractor, but they may sell products or services to clients.
As such, an independent contractor will receive IRS Form 1099-NEC (nonemployee Compensation), which was previously Form 1099-Misc, at the end of the year for their work done, while a sole proprietor may or may not receive a 1099-NEC Form.
Just like the self-employed individual, an independent contractor is self-employed, but may not be a sole proprietor.
Related: What title should I use as business owner?
Disadvantages of Sole Proprietorship
There are some disadvantages of sole proprietorships to consider before making the decision to start your business as one.
The main disadvantage to the sole proprietorship is that the owner has unlimited liability. This means that if the business can’t pay its debts or is sued, creditors can come after the owner’s personal assets to make up for what is owed. This is in contrast to business structures such as the LLC or corporation, which provide liability protection for the owner’s personal assets.
Related: 7 Disadvantages of the sole proprietorship
How do you register a Sole Proprietorship?
You don’t. The business structure of a sole proprietorship is considered legally the same as the individual operating the business. As such a sole proprietorship isn’t registered anywhere.
The only type of registration a sole proprietorship may have to do is register the business name. If the name of the business is going to be something different from the full first and last name of the business owner, they are typically required to register the name. Each state has different requirements, but the process of obtaining a business name is referred to as registering a Doing Business As, DBA, Fictitious Name, or Assumed Name.
Related: How to apply for a DBA
Does a sole proprietor need an EIN?
Possibly. An EIN or Employer Identification Number is a unique number that is assigned to a business. A sole proprietor will only need an EIN if they hire employees. If the sole proprietor won’t have employees, the owner will use their social security number as the unique number for the business.
Related: How to apply for an EIN
Do Sole Proprietors Get a 1099?
Possibly. If a sole proprietor does work for another company, such as a cleaning company that is contracted to clean an office every week, a 1099 Form would be issued at the end of the year. If the sole proprietor provides lawn care to homeowners, they would not receive a 1099 Form from the homeowners at the end of the year.
Can a sole proprietor have employees?
Yes, a sole proprietor can have employees. They will just need to obtain the necessary licenses and permits, as well as pay any required taxes.
Related: Hiring your first employee