5 Types of Self-Employment Arrangements and Their Pros and Cons

Introduction

In a nutshell, self-employment means a person makes their income by working for themselves rather than for an employer.

If you’re planning to work for yourself, you need to make a considered choice when choosing your legal structure. The type of self-employment has consequences for tax, paperwork, and reporting.

So what are the different types and their drawbacks and advantages? Which structure is right for you?

This guide outlines all the basics you should be aware of when choosing and changing your type of self-employment.

The five basic types of self-employment

Successful self-employment might require you to be an all-rounder. For example, as a one-person team, you might need to excel in sales, market, client management, payroll, and invoicing, along with your core business activity.

However, the flexibility in lifestyle and freedom to choose what they want to work on may be well worth it. Self-employment might give you a pathway to do work you’re passionate about. In some cases, you could generate a better income than if you were employed.

These are the five basic types of self-employment, along with some of their specific benefits and potential drawbacks.

1. Freelancer or independent contractor

Freelancing is one of the most popular forms of self-employment. Freelancers are also known as independent contractors.

Examples include a freelance photographer working at weddings and other events or a graphic designer producing work on a project-by-project basis. Other examples include web design, accounting, landscaping, and plumbing.

As a freelancer, you don’t work for a company on a guaranteed or permanent basis. Usually, you’re in complete charge of how you work. In other words, the person or business you’re contracted to work for only determines the results of the work you do.

Typically, you set your own pay and rates but state laws may vary on whether the contracting business is responsible for benefits and wages. One drawback, generally speaking, is you’re usually not covered by workers’ compensation. As such, you may need to organise your own coverage. Also, you need to pay your own Social Security and Medicare taxes.

2. Gig workers

Uber drivers and food delivery drivers are gig workers. Gig workers differ from freelancers in one key way: they tend to have little say over their work hours. Also, as a gig worker, you may be working on numerous jobs for different companies at the same time.

In contrast, a freelancer may work on one contracted project at a time and work on it for weeks or months. Gig work tends to be more short-term, such as making a food delivery.

In some cases, gig workers have been classified as employees, although most are considered independent contractors.

3. Sole proprietor

As a sole proprietor, you and your business are the same single legal entity. Unlike an incorporated structure (see below) where you’re separate entities, you legally receive all the revenue your business generates.

By the same token, a drawback is you and your personal assets are exposed to all the financial risks of the business and you are responsible for its debts.

Advantages include ease of setting up; you’re automatically a sole proprietor when you start your business. You have the flexibility of registering different business names or using your personal name to do business.

Also, you can hire staff to help you, but keep in mind you’ll need to comply with awards and minimum employment terms and conditions like any other employer.

Generally speaking, compliance requirements are less onerous, and you don’t need to file a separate business income tax return as it’s part of your personal income tax return.

In addition, there’s no asset protection as there’s no distinction between personal and business assets.

4. Partner

Partnerships are owned by you and at least one other person. Your profits and losses do pass through to you for tax purposes.

The four types in the US, with their advantages and potential limitations, are as follows:

1. General partnership - All partners share in the profits and losses on an equal basis unless they choose otherwise.
2. Limited partnership - This is where the partners co-own the business with silent investors who aren’t involved in the business and who aren’t personally liable for certain risks, decisions, and the business’s debts.
3. Limited liability partnership - Partners aren’t personally liable for the partnership’s business debts or the decisions of the other partners. They’re only responsible for their own decisions and actions concerning the partnership.
4. LLC partnership - This is a hybrid of LLC (limited liability company) and partnership where the partners aren’t usually personally liable for the business’s debts and activities. However, partners may be held accountable for what other partners do.

Partnerships tend to have more reporting requirements than sole proprietors and independent contractors.

5. Single-member LLC

With an LLC, your business is legally distinct from you as an individual. All transactions are carried out under the business’s name.

In a single-member LLC, you have a level of protection when it comes to liability for business debts and activities. Your personal assets are usually not at risk.

Like partnerships, LLCs are subject to pass-through taxation and the tax liability goes through the business to you as the business owner. You’re obligated to report your business’s profits and losses on your personal tax return and you’re taxed like a sole proprietor.

Like a partnership, LLCs have more reporting and compliance requirements than independent contractors and sole proprietors.

Conclusion

Self-employment can give you a lot of freedom, flexibility, and independence. You could potentially make much more money than as an employee.

However, it comes with more responsibility and in some cases, personal risk. You might have less financial security and you won’t have access to employer-provided benefits and perks.

Different self-employment structures have different implications in terms of risk, asset protection, tax, and reporting and paperwork. Understanding the different types is vital when you’re getting started. When your business changes and expands, you may also need to reconsider your structure.