If you’re thinking of starting your own business, you need to think about how to structure it. The simplest and most common structure is a sole proprietorship. Declaring your business a sole proprietorship doesn’t require any paperwork or formal actions; it’s the status you automatically have when you open a business by yourself. As a sole proprietor, your business is unincorporated, and you have complete control over operations because you are the only person running the business.
If you own a business and are preparing to file your federal or state tax return, here’s what you need to know about sole proprietorship taxes.
- What does sole proprietor mean?
- Sole proprietorship taxes
- Sole proprietorship tax deductions
- Filing taxes as a sole proprietor
What does sole proprietor mean?
As a business owner, you have to decide on a business structure. The structure you choose affects how much you pay in taxes, what paperwork you must file and your personal liability. There are several different structures to choose from, one of which is a sole proprietorship.
Sole proprietorships are for businesses owned by just one person. There is no limit on your personal liability, and your business income is reported on your personal tax return. This is in contrast to other business structures, which can involve multiple owners and limit your personal liability, or the amount you’re held responsible for in the event of an accident.
Unlike other business structures, which often require application forms and expensive filing fees, there is no added cost associated with forming a sole proprietorship. You don’t have to fill out paperwork, pay fees or jump through any hoops to get started, making it a good option when you’re just getting an idea off the ground.
Sole proprietorship taxes
Sole proprietorships are not separate business entities. Your business assets and liabilities aren’t separate from your personal assets and liabilities, so you are responsible for any debt your business incurs. As such, you are taxed as an individual, just like if you weren’t a business owner. Rather than having to fill out a separate business return, you report your business earnings and expenses on your personal tax return.
As a sole proprietor, the main difference you will experience filing taxes is that you’ll need to fill out Form Schedule C: Profit or Loss From Business (Sole Proprietorship) and attach it with your tax return. This form is a report of your income and expenses throughout the year, so it’s essential to maintain detailed records.
Sole proprietorship income tax
Since sole proprietorship owners pay taxes as individuals, you can find the sole proprietorship tax rate by looking at the income brackets for that filing year. For 2021, the following tax brackets apply:
|Sole Proprietorship Tax Income Tax Brackets for 2021|
Married filing jointly
Head of household
|10%||Up to $9,950||Up to $19,900||Up to $14,200|
|12%||$9,951 to $40,525||$19,901 to $81,050||$14,201 to $54,200|
|22%||$40,526 to $86,375||$81,051 to $172,750||$54,201 to $86,350|
|24%||$86,376 to $164,925||$172,751 to $329,850||$86,351 to $164,900|
|32%||$164,926 to $209,425||$329,851 to $418,850||$164,901 to $209,400|
|35%||$209,426 to $523,600||$418,851 to $628,300||$209,401 to $523,600|
|37%||$523,601 or more||$628,301 or more||$523,601 or more|
If you live somewhere that assesses state income taxes, you’ll also have to file a state personal tax return that includes your business’ profits and expenses.
Sole proprietorship self-employment tax
As a sole proprietor, you need to plan for self-employment taxes if you earn $400 or more from your business. With traditional employment, your employer covers a portion of Social Security and Medicare taxes; as a sole proprietorship, you have to pay both the employer and employee portions.
To do so, complete Form Schedule SE: Self-Employment Tax and submit it with your return. This form is what you use to calculate the Social Security and Medicare taxes you owe and is filed in addition to your Schedule C: Profit Or Loss from a Business (Sole Proprietorship) form.
Other sole proprietorship taxes that may apply
As your business grows, you may have to pay other forms of taxes in addition to your personal income taxes:
- Employee taxes: If you hire employees, you’ll have to withhold a certain amount of money from your employees’ paychecks and pay Social Security and Medicare taxes.
- Unemployment taxes: If you have employees, you have to pay unemployment taxes so that workers have compensation when they lose their jobs.
- Sales tax: If you’re selling products or services, you may have to collect and pay sales taxes. If your state requires you to collect sales taxes and you don’t meet that obligation, you may have to repay the sales tax that should have been collected. If you’re not sure what your state’s tax laws are, check with your state chamber of commerce.
- Property tax: If you own property or land used for your business, you may be subject to property taxes.
Sole proprietorship tax deductions
With tax deductions, you can reduce your taxable income, potentially lowering how much you owe the IRS. If you’re looking for sole proprietorship tax write-offs, there are multiple deductions you can claim; the ability to deduct your expenses is one of the key tax benefits of sole proprietorships.
As a sole proprietor, business deductions lower your taxable income on your personal return, so you’ll owe less and could qualify for a larger refund. You can deduct the following expenses:
- Health insurance: If you purchase insurance for yourself, your spouse or dependents, you can deduct the cost of your health insurance from your taxable income. You can claim the deduction even if you don’t itemize your taxes.
- Business equipment: As a business owner, you likely need some equipment for its operations, such as a computer, printer or other items. The cost of those items is deductible as long as they’re used for your business.
- Home office: If you primarily run your business from home and have a dedicated workspace just for your work, you can claim the home office deduction.
- Rent: If you rent an office space or manufacturing location, the rent is deductible.
- Business insurance: If you purchase insurance for your business, such as professional liability and errors and omissions coverage, you can deduct your premiums on your tax return.
- Business use of vehicle: If you use your vehicle solely for business purposes, you can deduct the total cost of operating the car. If you use your personal car occasionally for work, you can deduct the costs for business-related use, such as mileage for sales calls.
- Other expenses: Other business expenses, such as traveling to conferences, software or advertising fees can also be deducted.
Qualified Business Income Deduction
The Tax Cuts and Jobs Act of 2017 created a new deduction for business owners: The Qualified Business Income (QBI) Deduction. With this deduction, eligible taxpayers — including sole proprietors — can deduct up to 20% of their qualified business income. The IRS defines qualified business income as the net amount of income, gains, deductions and losses from a qualified business or trade.
If you have a Specified Service Trade or Business (SSTB), there are income restrictions on the deductions. The following fields are classified as SSTB:
- Actuarial science
- Financial services
- Performing arts
You can claim this business deduction in addition to your other personal deductions, which helps to reduce your taxable income even further.
Filing taxes as a sole proprietor
Filing taxes as a sole proprietor isn’t much different than filing your personal tax return as an employee. The biggest difference is that you may need to make estimated tax payments each quarter rather than paying your taxes once a year.
To minimize stress and ensure your tax return is accurate, be sure to keep records of business expenses and keep copies of receipts and invoices.
Using bookkeeping software like QuickBooks, FreshBooks or Wave can help to simplify taxes for sole proprietors. You can use software to track and send invoices, input expenses and receipts and run reports. Some programs, such as Quickbooks Self-Employed, will also calculate how much you owe each quarter in taxes so you can make your estimated tax payments. And, you can use these online tax software to file your tax return.
Finally, if your personal taxes are more complicated, or want an expert’s assistance, you may want to consult with a tax professional about filing taxes as a sole proprietor.
Sole proprietorship tax filing deadline
Taxes have to be paid as you earn money throughout the year. For regular employees, a portion of your paycheck is withheld for taxes every pay period. As a sole proprietor, you’re responsible for withholding money for those taxes yourself.
If you’re in business for yourself — and aren’t employed by anyone else — you’ll likely have to pay estimated taxes each quarter. Sole proprietors are required to make estimated tax payments if they expect to owe $1,000 or more when they file their tax returns. If you don’t, you could incur significant penalties.
The sole proprietorship tax filing deadline for estimated payments is as follows:
- April 15
- June 15
- Sept. 15
- Jan. 15
Sole proprietorship tax forms
If you aren’t sure how to file taxes as a sole proprietor, you should know they aren’t that much more complicated than preparing a personal tax return. As a sole proprietor, you’ll likely have to complete the following tax forms:
- Form 1040-Individual Income Tax Return: As a federal taxpayer, you must complete the individual income tax return. This form includes your earnings, deductions and tax credits.
- Form 1040-ES: The Form 1040-ES is what you use to calculate your estimated tax payments each quarter.
- Schedule C: To report your profits and losses from your business, complete Form Schedule C.
- Schedule SE: Use Schedule SE to determine how much you owe in self-employment taxes, including Social Security and Medicare payments.
- Form 8829- Expenses for Business Use of Your Home: If you plan on claiming the home office deduction, you must complete Form 8829.
- Form 941-Employer’s Quarterly Federal Tax Return: If your sole proprietorship hires employees, you must complete Form 941 each quarter to report how much money you paid toward Social Security and Medicare for each person.
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