Unlike a corporation, a sole proprietorship is not taxed separately from the business owner. Instead, the owner of the business is personally responsible for all tax liabilities and must pay those taxes on their personal tax return each year.
Here’s everything you need to know about filing taxes as a sole proprietor including required tax forms, tax deductions, and tax filing deadlines.
What is a sole proprietorship?
A sole proprietorship is a business structure where an individual operates a business as the sole owner is personally responsible for all liabilities. It’s one of the most common and simplest forms of business entities to set up in the US. If you start doing business without setting up a formal entity, the IRS views you as a sole proprietorship by default.
From a tax and legal standpoint, there is no distinction between you and your business. Your business income goes straight to your personal account, and you’re also responsible for all debts, and tax and legal obligations incurred by your business.
As the sole proprietor, you’re in complete control of all business decisions and can make and implement all decisions without having to consult or receive approval from anyone else.
How a sole proprietor files taxes
As mentioned above, all business income in a sole proprietorship is attributed to the proprietor of the business. However, the tax reporting requirements are slightly different from reporting income from a job.
Federal and state income taxes
With a sole proprietorship, you’re required to file two forms each year for your self-employment taxes. Form 1040 reports your personal income, while Schedule C reports your business income. You must list your business’ profits and/or losses on a Schedule C, Profit or Loss from a Business. This form is submitted along with your Form 1040, which is your individual tax return.
Your personal tax bracket is determined by combining your incomes from Form 1040 and Schedule C.
In a corporation, the business owner can choose to take home a smaller salary in order to pay less personal income taxes. In a sole proprietorship, because all business income passes through to the owner of the business, the owner’s tax bracket is based on the income of the business regardless of how much you take home.
On the bright side, it’s not your entire business’ income that gets taxed, only your profits.
As a sole proprietorship, you’re responsible for paying for your own Social Security and Medicare taxes.
In 2023, 12.4% of your self-employment taxes goes towards Social Security taxes, on up to the first $132,900 of your income, and 2.9% of your self-employment taxes goes towards Medicare tax.
These amounts are reported on Schedule SE each year when you file your federal tax returns.
Preparing for taxes
Unlike a day job, your employer won’t automatically withhold income taxes from your paycheck. You’re responsible for estimating your annual tax payments based on your income, and setting aside money to pay for taxes each year.
Also read: How Much Tax Does My Business Need To Pay?
Tax deductions for sole proprietors
One of the benefits of operating a business is that you can write off expenses as tax deductions.
Here are some of the most common tax deductions taken by sole proprietors:
Business Expenses: You can deduct ordinary and necessary expenses directly related to your business operations. This includes costs such as office rent, utilities, office supplies, equipment, marketing expenses, professional fees (e.g., legal or accounting services), business insurance premiums, and business-related travel expenses.
Home Office Deduction: If you use part of your home exclusively for your business, you may be eligible for a home office deduction. This deduction allows you to deduct a portion of your home-related expenses, such as rent, mortgage interest, property taxes, utilities, and home maintenance costs.
Vehicle Expenses: If you use a vehicle for business purposes, you can deduct the expenses associated with its use. This includes mileage or actual expenses like fuel, repairs and maintenance, insurance, registration fees, and depreciation. It’s important to keep detailed records of your business mileage and expenses to support your deductions.
Self-Employment Taxes: As a sole proprietor, you’re responsible for paying both the employer and employee portions of Social Security and Medicare taxes. However, you can deduct the employer portion of these taxes as an expense on your tax return, which helps reduce your overall tax liability.
Health Insurance Premiums: If you’re self-employed and not eligible for a health insurance plan through another source, you may be able to deduct the premiums you pay for medical, dental, or long-term care insurance for yourself, your spouse, and your dependents.
Retirement Contributions: Contributions to a retirement plan, such as a solo 401k, are tax-deductible. These contributions can help you save for retirement while providing a tax advantage. This can be one of the biggest tax deductions in your business, as a you can contribute up to $66,000 in tax-deductible contributions to a solo 401k for 2023.
Education and Training: Costs associated with continuing education, professional development courses, and workshops that directly relate to your business may be deductible.
When are taxes due for sole proprietorships?
Sole proprietorships need to file their general income tax returns on the same schedule as your personal tax returns, which are usually due by April 15th each year, unless it falls on a weekend or holiday. If an extension is filed, you generally have 6 more months to file, and the deadline would be October 15th each year.