You must declare all business revenue and losses on your income tax return as a sole proprietor; the business is not taxed separately. (The IRS refers to this as “pass-through” taxes since business profits are taxed on your tax return after passing through the business.)
Here’s a quick rundown of how to file and pay sole proprietorship taxes and their deductions with an explanation of when incorporating your firm can save you money.
What are the Sole Proprietorship Taxes?
A sole proprietorship is a pass-through entity for tax purposes. The money generated by the business “passes through” to the business owner, who reports it on their income tax return. This can help reduce the paperwork required for annual tax filing. However, it is critical to understand which sole proprietorship taxes you will be required to pay.
A sole proprietorship must pay the following taxes:
- The federal income tax
- State income tax.
- Self-employment tax.
- Estimated federal and state taxes
- If applicable, sales tax.
Each sort of tax has its reporting and payment obligations.
#1. Federal and state income taxes:
To pay federal income taxes for the year, sole proprietors must file two forms. The first is Form 1040, which is the individual tax return. Schedule C, on the other hand, reports business profit and loss. Form 1040 reports personal income, whereas Schedule C reports business income.
The total income from Form 1040 and Schedule C determines your tax bracket and the amount of income tax owing. If your state collects income tax, you will transfer your income figures from your federal forms to your state forms to establish how much income tax is owed. Again, your income tax burden is determined by the tax bracket in which you fall based on your combined business and personal income.
#2. Self-employment taxes:
If you work for someone else, they are responsible for deducting Social Security and Medicare taxes from your compensation. If you are a sole owner who is entirely self-employed, you must pay this sole proprietor tax yourself.
#3. Estimated taxes, including federal and state:
Estimated taxes are not a different type of tax. When you pay anticipated tax, you’re essentially putting money aside for what you expect to owe in income and self-employment tax at the end of the year. Typically, your company would deduct money from your paychecks to cover your tax liability. However, you must do this yourself if you are a self-employed sole owner.
Estimated federal and state taxes are due in January, April, June, and September. The current tax year’s first tax payment is due in April. As a result, the final is due in January next year. Filing deadlines are usually on the 15th of the month unless the 15th falls on a holiday or weekend. The filing deadline would then be the following regular business day. One can use form 1040 ES to file sole proprietorship taxes. You must, however, file your income taxes for the preceding year in April.
It is critical to ensure you pay enough due taxes each quarter. If you underpay your estimated taxes, you may face an underpayment penalty if you owe extra taxes at the end of the year.
#4. Sales taxes:
If your company sells goods or services, you may be required to collect and remit sales tax. Your home state determines how you pay and collect this tax. Your state’s revenue department can tell you if and when you must pay and file taxes.
Special Deductions for Sole Proprietorship Taxes
However, while some financial activity in your firm does not affect your taxable income as a sole proprietorship, there is also a non-cash activity that might reduce your taxable income – but these activities may not display on your profit and loss statement.
When it comes to your sole proprietorship taxes, keep these important and sometimes neglected business tax deductions in mind, as they can significantly impact your tax liability.
#1. Health Insurance Deduction
Many sole entrepreneurs are unaware that they can deduct health insurance premiums for themselves and their families even if their tax returns are not itemized. If you are a sole proprietor, your health insurance premiums are an “above the line” deduction, which means you can deduct them before calculating your AGI. However, it would help if you kept in mind that this only applies to the payment for months when a group health plan does not cover you (or your spouse or other family members).
#2. Business travel expenses
Although the business mileage deduction is not limited to sole proprietorships, sole owners frequently miss it because they believe it is unimportant. However, if you use your car for business purposes, this deduction might significantly influence your tax liability at 57.5 cents per mile (in 2020). To claim this deduction, you must keep detailed mileage records, but luckily, a variety of online business apps can help with this process.
#3. Home Office Deduction
Many sole proprietors are hesitant to claim the home office deduction because they’ve heard it’s a red flag that makes their tax return more vulnerable to an audit. However, if you run a home-based business, you are eligible for this deduction, which can considerably impact your tax liability. However, keep in mind that you can only deduct expenses for the percentage of your home that you use for your business. Furthermore, your home office area must be used primarily for business; therefore, you can’t take this deduction if your “office” is a corner of your kitchen table.
#4. Self-employment Taxes
When you work, your employer pays half of your social security and Medicare taxes, and the other half is deducted from your paycheck. As a sole proprietor, however, you are personally liable for these taxes. These are self-employment taxes, and the current self-employment tax rate is 15.3 percent of your net self-employment income. Half of your self-employment taxes are deductible. These particular sole proprietorship taxes are recorded on a unique form called Schedule SE, which we’ll go over in more depth below.
We recommend consulting with an accounting professional to ensure you optimize your sole proprietorship tax deductions. Bench users can be linked with an experienced bookkeeper who will handle all of their tax filing needs.
How to File Your Sole Proprietorship Taxes
Keeping everything we’ve covered so far in mind, let’s go into the specifics of the many forms you’ll need to file to satisfy your obligations for sole proprietorship taxes. At this point, it’s important to note that, while we’ve focused on your company’s income tax burden, you may also be liable for other taxes, such as payroll, property, sales, and excise taxes. In this regard, the IRS publishes a reference list of taxes for which sole proprietorships may be and as the paperwork required for each tax.
#1. Self Employment Income and self-employment taxes
As previously stated, as a sole proprietor, you must record and pay income taxes of the firm’s profits do so by filing additional forms with your personal return, Form 1040. Most sole owners only need to file two forms with their returns. Let’s take a closer look at each of these types.
#2. Schedule C
First, Schedule C is utilized to disclose your company’s earnings and losses. This form will also be used to submit your company mileage.
Schedule C is a simple form divided into five sections that ask about your income, costs, cost of products sold, car details, and other expenses. When filling out this form, you can consult IRS instructions for advice and most of the information you’ll need from your financial accounts and, if relevant, your mileage monitoring app.
However, there are a few queries that require an explanation right away:
- Accounting method: You will be questioned about your company’s accounting technique in the first section of Schedule C. Even if they keep their books on an accrual basis, most sole proprietors file their taxes on a cash basis. Unless your accountant advises you otherwise, you should file your tax return on a cash basis. This ensures that you only pay taxes on the income that you received.
- Material participation: If you are actively involved in your firm’s operations, you will respond “yes” to this question. If you are an investor or have passive revenue from your business, consult your accountant about how to continue with your tax return.
- 1099 filing requirements: If you paid one or more independent contractors at least $600 throughout the year via check, cash, electronic funds transfer, or wire transfer, you must file 1099s for them. If you paid your contractors with a credit card or through a service like PayPal, the merchant processor is in charge of filing the 1099s.
Finally, you’ll use the Schedule C information to complete your personal 1040 tax form. The sole proprietorship tax rate you’ll pay on your business’s income will be equivalent to your income tax rate.
#3. Schedule SE
As previously stated, as a sole proprietor, you are responsible for self-employment taxes, the social security and Medicare taxes that an employer would ordinarily deduct from an employee’s compensation. To compute the self-employment taxes you owe, complete Schedule C first, followed by Schedule SE. The current self-employment tax rate is 15.3 percent; however, you can deduct half of this on your 1040 form.
It’s crucial to note, however, that while you must file Form 1040, Schedule C, and Schedule SE annually, you must pay self-employment taxes quarterly. To compute these payments, known as estimated taxes, you’ll use Form 1040-ES and pay the amounts quarterly, according to the IRS due dates.
Additional Sole Proprietorship Taxes
In addition to your sole proprietorship taxation responsibilities for income and self-employment, depending on the nature of your firm, you may additionally be due for the following taxes:
- Employment taxes: If your sole proprietorship employs people, you must pay employment taxes, generally known as payroll taxes. This entails withholding tax from your employees’ paychecks for income taxes, FICA (Social Security and Medicare) taxes, and unemployment taxes, as well as reporting and paying your respective employer taxes. Forms 940 and 941 must be completed to report and pay these taxes. Additionally, you’ll be obliged to disclose an employee’s earnings and tax withholdings annually by filing Form W-2 (if you’re reporting payments to independent contractors, you’ll file 1099s instead).
- Property taxes: You may be obliged to pay property taxes if your sole proprietorship owns real estate, land, or any business property. The amount of business property tax you must pay is determined by your location and the guidelines established by your local tax authority.
- Sales and excise taxes: At the state level, your sole proprietorship will be required to pay sales taxes on the taxable services and items you sell. Sales taxes, like company property taxes, will vary depending on your location and product or service, so check with your state tax department for the specifics. Similarly, you will only be required to pay excise taxes if you sell specific products, such as alcohol or cigarettes. If you must pay excise taxes, you must do so at the federal, state, and local levels, which means the location of your firm will determine the cost and schedule.
When Should a Sole Proprietorship File Its Taxes?
Finally, the tax will determine the returns for your sole proprietorship taxes. In this vein, remember that some tax returns, such as Form 1040 and the accompanying Schedule C, must be completed annually, while others, such as Form 941 for payroll taxes, must be filed quarterly.
You must complete the relevant papers for your sole proprietorship on the exact timetable as your tax returns to file your general income taxes. As a result, you must file by April 15 unless you file an extension, which gives you until October 15 to file.
However, as previously stated, the IRS requires you to pay this tax burden throughout the year. You must complete Schedule SE to compute your estimated tax payments and pay the appropriate amounts quarterly.
Although there are various deadlines to meet, you should maintain track of your tax obligations, pay your anticipated taxes, and file on time. The IRS may impose a late payment penalty if you do not pay your estimated taxes and wait until you file your annual return. Similarly, any IRS company form you do not complete by the deadline may result in a penalty.
Sole Proprietorship Taxes FAQs
How much do you pay in taxes as a sole proprietor?
Sole proprietors must pay the entire amount (although they can deduct half of the cost). The self-employment tax rate is 15.3 percent, including 12.4 percent for Social Security up to an annual income maximum (beyond which no tax is levied) and 2.9 percent for Medicare with no income limit or ceiling.
How often do sole proprietors pay taxes?
An annual basis, a sole owner will file a Schedule C along with their personal 1040 tax return. They will also be responsible for filing Schedule SE with these returns and paying quarterly self-employment taxes.
Can a sole proprietor get a tax refund?
Yes. When the predicted tax payments made during the year exceed the tax burden based on the company’s overall profit and loss, sole proprietors are entitled to a tax rebate.
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