The Modern Version of the Subsistence Farming

Back around the time of the revolution, the republican ideal of citizenship (that's republican as in "republic," not the political party) was a man owning and working a farm. Ownership, in those days, extended not only to the land and the animals, but human beings as well, most notably, members of one's own family. A man's wife and his minor children were thought of as his property and were an invaluable part of the workforce. Women's sufferance and child labor laws have put pretty strict limits on the modern application of that economic model, but the ideal that a citizen should be his own master lives on amongst the self-employed.

The number of sole proprietorships filing taxes in the U.S. reported by the IRS has been growing steadily over the past decade, at a rate of a few hundred thousand new businesses a year. At the end of the 2000 tax year, there were almost 18 million sole proprietorships in the U.S., just over 5 million corporations (many of them S-corps, or family corporations) and around 2 million partnerships. The total reported income of the sole proprietorships  was just over 1 trillion dollars, compared to over 2 trillion for the partnerships and almost 20 trillion for the corporations.

The growth of corporate income over the decade was almost double that of the growth of sole proprietorship income. Net income (profits) tell a different story, with sole proprietorships reporting approximately 20% of their gross proceeds as profits, while corporations reported around 5% of their receipts as profits. One suspects that corporations have much better tax attorneys than small entrepreneurs.  Partnerships fell in the middle, reporting around 12% of their sales as net profit, but it's more interesting to look all the way back to the 80's when partnerships (in total) sometimes averaged out to a loss for the year. Can you say loopholes, tax shelters, and out-and-out fraud?

It's also interesting to look at the average size of the take from IRS statistics. In the year 2000, over 10 million non-farm sole proprietorships (2/3 of the total) had gross receipts less than $25,000. The average net income for all sole proprietorships was a hair over $12,000 dollars that year, not much of a living for those doing it full time. The number of sole proprietors earning more money trails off steadily with each increased bracket, and only 57,000 earned over 1 million dollars. Well over half of corporations filing taxes earned over 100,000 dollars in the year 2000, and nearly a million corporations earned over 1 million dollars. Almost a quarter of corporations, however, came in at the low end, reporting under $25,000 in profits. The average corporation reported $184,000 in net profits, so you can see how much the low end drags down the curve:-) The average partnership reported $116,000 in profits.

Staying with sole proprietorships (which reflect the greatest number of self-employed), the greatest number of returns filed were for "Professional, scientific and technical services," at nearly 2.5 million businesses, with "Retail trade" following just a hundred thousand behind. The next in line, right around 2.25 million businesses was "Construction," with nearly three quarters of these filing as "Special trade contractors." Other categories with over 1 million filings were, "Health care and social assistance," at just under 1.6 million businesses, "Administrative support and waste management and remediation systems," at 1.5 million (don't ask how they got lumped together in a category). "Arts, entertainment and recreation," filings were nearly identical with "Personal and laundry services," at about 1.075 million businesses each. Makes you wonder if each of those entertainers employs a personal assistant to do laundry. The funny thing is that the personal services filers actually out-earned the entertainment filers by over 40%. That agrees with the old truism that the boarding houses, grocers and laundries made all the money during the gold rush, not the miners.

If you've ever wondered what other businesses do when they fill out their Schedule C deductions, the following data published by the IRS should fill in the gaps. In the year 2000, sole proprietorships reported just over 1 trillion dollars in gross income. The leading deduction, at $387 billion (cumulative) was "Cost of Goods Sold/Operations", of which the three highest components were "Purchases," at around $269 billion "Materials and Supplies" at $43 billion, and Labor costs", about $29 billion. The next biggest deductions were "Salaries and wages," at almost $63.5 billion, "Car and truck," expenses at just over $45.7 billion and "Rent paid," and "Depreciation," nearly tying at $33 billion and $32 billion respectively. "Utilities," clocked in at $19.4 billion, "Taxes paid," just missed $14billion and "Insurance," followed at $13.6 billion. "Repairs," came in just under $12.3 billion, "Interest paid," came in at $12.2 billion, and "Commissions," a surprising (to me) $11.6 billion. The lowest three deduction categories were "Office Expenses" at 10.5 billion, "Advertising," at $10.1 billion and "Pension and Profit sharing plans," came in last at less than $900 million.

Just for fun (groan) I figured out what percentage each listed business deduction on Schedule C amounted to, though the total doesn't add up to 100% due to unlisted items. And we have:

Schedule C year 2000 Items	Percentage of total deductions
Purchases (Cost of Goods)	33.3%
Labor Cost (Cost of Goods)	3.6%
Materials & Supplies (C.O.G)	5.3%
Advertising	1.3%
Car and Truck Expenses	5.7%
Commissions	1.4%
Depreciation	4.0%
Pension and Profit Sharing	0.1%
Insurance	1.7%
Interest Paid	1.5%
Office Expenses	1.3%
Rent Paid	4.1%
Repairs	1.5%
Salaries and Wages	7.9%
Supplies	2.7%
Taxes Paid	1.7%
Utilities	2.4%

One of the most obvious facts to fall out of this data is that most sole proprietorships are in fact self-employed entrepreneurs with no payroll. Otherwise, the salaries and wages would have come in at higher than 7.9% of total expenses, but I suppose this was also obvious from the average gross income of these businesses being just $57,000, and average net income at $12,000. Clearly most of these businesses are involved in selling something material rather than pure services, as shown by 48% of deductions being for goods purchased, so there just can't be much left for paying employees.

One of the greatest challenges the entrepreneur faces is if and when to transition from pure self-employment to taking on a hired hand or two. The ability to hire contract workers (1099's) for specific jobs as defined by the IRS gives the entrepreneur the option to remain self-employed while accessing skills and manpower that would otherwise be unavailable without hiring employees and taking on all of the burdens of tax reporting and other social contract responsibilities.

I haven't received a W-2 (Employee Compensation) since 1992, and for sixteen years now I've been subsistence farming without a farm (though I've often thought about buying one). My goal was always to be manufacturing, rather than service, though service paid the bills in the early days. The problem with doing service work as a self-employed entrepreneur is that you are selling your time. The only way to grow the business is to sell more time, and while you're on the clock, it's just like being a wage slave. For me, manufacturing meant developing a product, a way to produce it, market it and sell it. I invested some serious time and what little money I had into developing educational CD-ROM's in '94 and learned my most important lesson about self-employment from the failure to complete a product. If you have to take on partners, you aren't self-employed, you're in a partnership. I entered into two content development partnerships that year without any legal agreements and got left holding the bag in both cases - my stupidity.