When it comes to the employee vs. self-employed issue, are you unsure of your tax status with the IRS? This is a critical question and one that you must answer before filing your next income tax return. There could be thousands of dollars of taxes at stake here, so let’s help you sort this out.

Does the IRS view you as a self-employed person? How do you know? Here’s a straightforward definition of self-employment: If you engage in a trade or business as a sole proprietor or an independent contractor, you are self-employed in the eyes of the IRS.

But this definition contains several more terms that need definition. So let’s take a look at each one in our attempt to get a more complete understanding of self-employment.

What is a trade or business?

Generally speaking, if you conduct an activity with the motive to make a profit, that activity is considered a trade or a business. This activity can be either full-time or part-time. And this activity can be profitable or unprofitable. The key here is whether or not your intent is to make a profit, regardless of whether you do so or not.

What is a sole proprietor?

Simply stated, if you own an unincorporated business by yourself, you are a sole proprietor. In other words, if your business is a corporation, you are not a sole proprietor.

What about a Limited Liability Company (LLC)? Isn’t that like a corporation? A single-member LLC can choose to be taxed as a corporation. But if a single-member LLC doesn’t elect to be taxed as a corporation, then the owner of a single-member LLC is automatically treated as a sole proprietorship for tax purposes, without losing its legal status as an LLC.

What is an independent contractor?

Many people who offer their services to the public are independent contractors: examples include accountants, attorneys, skilled trade contractors (carpenters, electricians, plumbers, painters, etc.), physicians, and consultants. In some situations, these people may be employees of a business. In other situations, they are independent contractors. The particular circumstances of each situation determine whether someone is a contractor or an employee. But if you are not an employee and are engaged in these types of services, you are an independent contractor and are self-employed for tax purposes.

One final all-important question: Why does it matter? Why is it so important that you know whether or not you are self-employed? Answer: because a self-employed person is taxed differently than an employee. The tax deductions for a self-employed person are significantly different than the tax deductions for an employee. And you must file different tax forms. So you must know the answer to this question, or you will run afoul of the IRS.