Understanding the Distinction Between a Freelancer, Self-Employed, and Employee
WHO IS CONSIDERED A FREELANCER?
In general, when we refer to a freelancer, we don't usually mean someone who intends to create a typical company and operate from a permanent office. Instead, a freelancer is typically someone who is self-employed and operates as a "sole proprietor." As a self-employed person, a freelancer can hire employees if they can afford to do so. Freelancers work in a variety of industries, including consulting, web design, and IT programming. Typically, freelancers have lower business costs and financial risks than traditional businesses. In Danish, a freelancer's income is referred to as "honorar," which doesn't have a direct equivalent in Polish. It is a type of income that falls somewhere between a salary and the revenue generated by a sole proprietorship. For the purposes of this article, we will refer to it simply as "income."
FREELANCER RECEIVES INCOME B
When it comes to taxes, a freelancer's income is classified as "B-income," which is the same as for a sole proprietor. The tax paid by a freelancer is also called "B-tax," which is the same as for a sole proprietor. However, just because both the income and tax are labeled "B," it doesn't necessarily mean that a freelancer is considered self-employed. The "B" designation simply lets the IRS know that the income was not earned from a regular job (i.e. "A income"). Being a freelancer can make it tricky to figure out the appropriate tax category and accounting and VAT obligations. It's possible that you only consider yourself a freelancer because of the contract you signed with your client, but in Denmark, it's not possible to decline being an employee even if your contract states otherwise.
FREELANCER WHO IS CONSIDERED AN EMPLOYEE
WHAT IS THE DIFFERENCE AMONG BEING AN EMPLOYEE, FREELANCER AND SELF-EMPLOYED?
Typically, we have to be ready for 3 possible scenarios
FREELANCER WHO IS CONSIDERED AN EMPLOYEE
If certain qualifications are met by a freelancer, they are legally classified as an employee:
1. The freelancer only has one employer or one main client.
2. The contract between the freelancer and their client is ongoing and does not have a specific deadline for completion.
3. The client provides instructions on the work to be done by the freelancer and has control over their work.
4. The client chooses the specific equipment and programs the freelancer should use.
5. The freelancer cannot hire others to do the work.
6. The freelancer bears no financial risk as they will always be paid for their work.
7. The freelancer does not incur any costs associated with doing the work.
8. The client's company brand name is used on all documentation.
9. The freelancer's work hours and vacations are agreed upon or set by the client.
10. The contract is concluded without specifying a specific duration.
11. The contract provides for a notice period.
12. The freelancer is paid on an hourly, weekly, or monthly basis.
13. The client covers the costs associated with the work performed, including vacation and employee insurance.
Instead of invoicing their services, employees receive a pay stub
When you're employed, you'll receive a regular pay stub, so don't submit invoices if your client is also your employer. The income you receive as an employee is called A-income, and the tax you pay is referred to as A-tax. Your employer or client is responsible for collecting and paying the A-tax to the IRS. As an employee, you'll also receive standard benefits such as vacation time.
Employees are not allowed to deduct expenses in personal income
As an employee, the expenses you incur cannot be deducted as they can be in a company. Instead, they are considered typical employment costs and are subject to a lower tax deduction than those of a company. These costs can only be deducted from taxable income, not personal income, and must be related to the income received from your employer. To declare these expenses, use field No. 58 for employee expenses on your tax return. Your income is declared in the standard salary field No. 11, and you don't need to use the fields for sole proprietors. Additionally, you're not required to pay VAT as an employee, regardless of your income, and you don't need to keep a record of your financial transactions.
A FREELANCER WHO IS NOT AN EMPLOYEE AND NOT SELF-EMPLOYED
Sometimes there exists a category of workers who fall between the spectrum of being hired as an employee and being self-employed, known as "true freelancers". It's important to note that no single factor can fully determine whether someone is a true freelancer or not, as there are many factors to consider.
However, some factors that may suggest you're a true freelancer rather than an employee or self-employed include:
1. You have multiple clients, not just one.
2. You bear a certain level of financial risk in your work.
3. You don't plan on running a large company, but prefer to work independently.
4. Your contract terms vary depending on each individual client.
5. Your projects are short-term and well-defined in scope.
6. Your work is limited to a specific time frame.
7. You have autonomy over how you perform your work.
8. You set your own working hours.
9. You choose the equipment and software you use to perform your work.
10. Your client cannot give you instructions on how to manage your work.
11. Your client cannot control your work or dictate how it is performed.
12. You receive payment once the project is completed and delivered.
13. You use your own company brand name in your work and documentation.
14. You are responsible for covering your own office, computer, and other expenses.
15. You may work for multiple clients simultaneously.
16. You have the ability to hire employees or subcontractors.
17. You must advertise to receive new projects.
18. You may face civil liability if you make a mistake.
19. You must be registered as a VAT payer.
20. You are not entitled to paid vacation or sick leave.
21. You determine when you take time off.
22. Your contract is terminable with no notice (although most contracts do have a notice period, it is not structured like an employment contract).
What deductions are possible in the case of a freelancer?
As a freelancer, you can deduct your expenses from your income, but your expenses cannot exceed your income, and you cannot end the year with a deficit as a sole proprietor can. If a company pays you "honorar," they must declare the income in box 12 on their tax return. If they don't, you must enter the amount in box 15.
You must declare your costs in box 29 on your tax return as a freelancer. It's essential to be able to provide documentation for all of your expenses.
Freelancers often have to pay VAT
When a freelancer earns over DKK 50,000 in revenue/sales within a 12-month period, their entire income becomes subject to VAT regulations, and they must comply with them. Sales made before the DKK 50,000 threshold was reached will also be subject to VAT, resulting in a 20% VAT charge (the VAT rate in Denmark is 25%, so 20% of DKK 50,000 equals 25% of DKK 40,000) that the freelancer must pay for all previous sales. However, not all freelancers have to pay VAT even if their sales exceed DKK 50,000. This exemption may apply to actors, musicians, artists, journalists, bloggers, speakers, writers, and translators, among others.
It can be difficult to distinguish between being an employee, a true freelancer, and being self-employed. However, a freelancer may appear to be self-employed if their work starts to resemble a serious business, and they take on more financial risks. For example, if a freelancer plans to hire staff and open their own office, they would face similar conditions to those of the freelancer mentioned in example 2 above, but on a more advanced level. This would be an indicator that the freelancer's activity is evolving into a more significant business.
What a PMV is?
In Denmark, it's possible to run a small sole proprietorship without having to pay VAT, as long as sales remain under DKK 50,000 within a 12-month period. To do this, you'll need to register a PMV ("Privat Mindre Virksomhed"), which is a smaller version of a sole proprietorship. If you don't expect your sales to exceed DKK 50,000 within a 12-month period, this is a good option. However, if you think your sales may reach or exceed this amount, it's better to register as a VAT payer from the beginning.
If your PMV sales do exceed DKK 50,000 within a 12-month period, any sales you made before reaching this threshold will be subject to VAT. The VAT rate in this case is 20%, which you'll need to pay on all previous sales. A PMV gets a CVR number but does not have VAT registration. However, if you later want to convert your PMV to a sole proprietorship and register for VAT, your CVR number will remain the same.
To summarize, a PMV is a smaller version of a sole proprietorship that doesn't require VAT registration and sales should never exceed DKK 50,000 for a 12-month period. In contrast, a sole proprietorship is registered for VAT, has a CVR number, and can have sales that exceed DKK 50,000 in a 12-month period.
What is a sole proprietorship?
In Denmark, the terms "self-employed" and "sole proprietorship" are interchangeable. If a sole proprietorship expects its sales to exceed DKK 50,000 within a 12-month period, it must register as a VAT payer. A sole proprietorship is typically established to generate a profit, and the owner must cover the costs of running a business, such as marketing, employees, office rent, computers, machinery, etc.
One-person business owners typically take on more financial risk than a freelancer when it comes to dealing with clients, and there's no fixed amount that can be used to determine this risk.
Factors indicating that you are a sole proprietorship:
1. You work for multiple customers.
2. You enter into contracts with a variety of terms.
3. Your projects are short-term and well-defined.
4. Your work is limited to a specific time frame.
5. You have autonomy over how you perform your work.
6. You set your own working hours.
7. You choose the equipment and software you use to perform your work.
8. You are not instructed by clients on how to do your work.
9. Clients cannot control your work or dictate how it is performed.
10. You receive payment once the project or milestones are delivered.
11. You use your own company name in your work and documentation.
12. You are responsible for covering your own office, computer, and other expenses.
13. You may work for multiple clients simultaneously.
14. You have the ability to hire employees or subcontractors.
15. There is a financial risk if, for example, you make mistakes or are late with project deliveries.
16. You create ads to receive new projects.
17. You may face civil liability if you make a mistake.
18. You are a VAT payer.
19. You are not entitled to paid vacation or sick leave.
20. You determine when you take time off.
21. It's possible to terminate a contract without notice.
The text states that self-employed freelancers need to follow accounting standards and suggests using e-conomic for accounting.
It also mentions that running a sole proprietorship requires declaration on the tax return using specific field numbers on SKAT Borger:
- Profit: 111;
- Deficit: 112;
- Income, interest: 114;
- Expenses, interest: 117.
WHAT IF I’M UNSURE IF I’M AN EMPLOYEE, FREELANCER OR SOLE PROPRIETOR?
The text explains that it is not always possible to determine with complete certainty whether a person is an employee, freelancer, or sole proprietor based on the factors mentioned. Sometimes it's clear that one is a sole proprietor, and other times it's clear that one is an employee, but often it can be difficult to determine. If someone is unsure about their status, they can ask the tax office for written confirmation, which costs around DKK 400.
WHAT ARE THE RISKS FOR YOU AND THE CLIENT IF YOU ARE FOUND TO BE AN EMPLOYEE RATHER THAN A FREELANCER OR SOLE PROPRIETOR?
There are two main points to consider. Firstly, if you are working for a client without proper compliance with employment regulations, both you and your client may face penalties and tax liabilities, which could be caused by factors such as wrongful termination, lack of an employment contract, or failure to receive vacation. Secondly, if you are a sole proprietor and have deducted expenses from your personal income, the tax deduction may be reduced due to different tax rules, and if you have previously declared a deficit, you may receive a tax bill instead.