Understanding Sole Proprietorship Taxes

This article is not intended to be financial advice.

Operating as a sole proprietor is the simplest and most common way to start a business. If this term is new to you, a sole proprietor is anyone who runs an unincorporated business by themselves, or who has a registered LLC that they elect to treat as a sole proprietorship instead of a corporation or partnership. 

In other words, if you’re selling goods or services and haven’t set up any formal business structure, you’re actually already a sole proprietor.

The downside of running any sort of business is that you have to pay taxes. The good news is that sole proprietorship taxes are surprisingly simple. Read on to get all your questions answered—from “How does a sole proprietorship pay taxes?” to “What can I write off on my taxes as a sole proprietor?”—so you can start (legally) making bank from your business.

How are Sole Proprietorships Taxed?

Sole proprietorships are taxed as “pass through entities,” which sounds complicated but really just means that your business income isn’t taxed separately from your personal income. Instead, tax on sole proprietorships is calculated as part of the owner’s personal income tax. 

Some people may be wondering, “Do you pay more taxes as a sole proprietor?” That’s a bit complicated to answer. The income tax rate that will be used to calculate your base taxes is the same as if you were a salaried employee—it can just sometimes feel like you’re paying more than when you were salaried since you have to hand that money over to Uncle Sam yourself rather than it magically disappearing from your paycheck. 

However, you are responsible for some extra taxes as a sole proprietor—specifically the Social Security and Medicare taxes that employers typically pay half of. These self-employment taxes will add to your tax bill each year (see the current rate here), though you get to write off half that cost.

Depending on what your business does, you may also have additional taxes to pay, including:

• Employment or payroll taxes, if you have employees
• Property taxes, if you own real estate or land for your business
• Sales taxes, if you sell products or certain services (varies state to state)

As you’re growing your business (and making more moolah), considering other business structures (like an S Corp) could be a way to help you save money on taxes, but they will also make your tax filing more complex and can lead to additional costs in other areas. It’s always worth chatting with an accountant about what makes the most sense for you.

Sole Proprietor Tax Benefits

Filing taxes as a sole proprietor has several benefits compared to other business tax filing. For one, it’s much simpler than corporate business taxes (and, therefore, often cheaper if you hire an accountant to help).

A bonus benefit specific to folks who are self employed is that you can deduct the cost of your health insurance premiums, as well as those of your spouse and other dependents, so long as you or your spouse aren’t eligible for an employer-sponsored program. 

Sole Proprietorship Tax Deductions

Perhaps the biggest benefit of sole proprietorship taxes is the tax deductions for sole proprietors. Like any company, you can deduct certain business expenses from your taxable income, therefore reducing your final tax bill. 

There are so many things you can write off that it’s always worth checking with an expert to make sure you aren’t missing anything, but common sole proprietor tax deductions include:

• Advertising expenses, from website costs and business cards to online or traditional ads
• Car and truck expenses, such as mileage put on your car for business purposes
• Commissions and fees, such as commissions you pay for affiliate marketing, or payment or merchant processing fees from platforms like PayPal or Etsy
• The cost of hiring people, including wages for full-time employees or fees for contractors
• The cost of goods sold (a.k.a., the cost of the raw materials that go into objects you sell)
• Depreciation of expensive equipment
• The cost of employee benefit programs
• Insurance (other than health), such as liability or event insurance
• Interest you paid on business credit cards, loans, or other lines of credit
• The cost of legal and professional services
• Office supplies or other supplies needed for your business
• Anything you rent or lease for your business
• Repairs and maintenance of equipment or office space
• Travel costs specifically for business purposes (including 50% of business meals)
• Businesses licensing fees
• Utilities for running your business
• Educational or conference expenses
• Software subscriptions needed for your business

Of course, it doesn’t make sense to ball out on buying these sole proprietor tax deductions if you don’t need them just to try and save on your taxes—ultimately, that’s still money out the door. But if there are things in these categories you need to run and scale your business, make sure you’re taking advantage of as many tax deductions for sole proprietors as you can.

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How to File Sole Proprietorship Taxes

The other downside of any business taxes is that the days of thinking about them once a year and forgetting about them until next April are over. Here are all of the steps you’ll want to take throughout the year to properly pay your tax on sole proprietorships. 

Track Your Income and Expenses

To start, make your job easier by properly keeping track of your income and expenses as they’re happening—rather than having to scramble and find records once it’s time to file taxes. 

You can do this using a simple spreadsheet to note when you get paid or when you buy something for your business, or find an invoicing and accounting software like QuickBooks or Wave that will connect to your accounts and automatically track income and expenses. Many small business owners also recommend opening a separate checking account and credit card specifically for your business expenses to make it easier to separate business expenses from personal ones.

Regardless of what system you choose, make sure to keep copies of invoices and receipts in a central location that’s easy for you to find—if you ever get audited, the IRS will want to see proof of your income and expenses.

Pay Quarterly Estimated Taxes

If you know you’ll owe more than $1,000 in taxes in any given year, pay attention. Every few months, you’ll have to hand some of your money over to the government  to start paying off your estimated tax bill for the year. That’s because the government has bills to pay, too, and doesn’t want to wait for your money. Salaried employees pay taxes with each paycheck—since sole proprietors don’t do that, you have to make up the difference with a payment every few months. 

Even though it’s called “quarterly” taxes, the due dates don’t quite line up with typical business quarters. You’ll need to pay estimated taxes on the following schedule:

• April 15: For money made from January 1 – March 31
• June 15: For money made from April 1 – May 31, payment due by 
• September 15: For money made from June 1 – August 31
• January 15: For money made from September 1 – December 31

You can easily pay your estimated taxes online or mail a check in along with Form 1040-ES. Depending on the state you live in, you may also need to pay quarterly estimated taxes, so make sure to research their requirements, tax rates, and payment options.

Use a Sole Proprietorship Tax Calculator

So, how do you figure out how much you owe each quarter? The IRS has a form to help, but it’s a bit complex. There are also plenty of quarterly tax calculators online, or an accountant can help you out. 

Some people wonder, “Do sole proprietors get tax refunds?” It depends on how well you’ve calculated your quarterly estimated taxes. If you’ve overpaid, expect a refund—if you’ve underpaid, you’ll owe the government some money.

File a Sole Proprietorship Schedule C

When it’s time to file your annual taxes, you’ll want to use a Schedule C to report the profit or loss from your business and your final sole proprietorship tax bill for the year. While it’s got a lot of lines, for the most part it’s just breaking down what you made and what you spent—if you’ve been tracking well throughout the year, this shouldn’t be too hard. 

One line that often trips up new business owners is the accounting method. You’ll want to choose an accounting method for your business and stick to it. Most small-business owners choose the cash method, which means you’re only paying taxes on money you’ve actually been paid. The accrual method means you’re tracking money based on when you invoiced for it, whether it’s been paid or not (a.k.a., you may be paying taxes on money you don’t have.)

If you’re also deducting the cost of health insurance premiums, you’ll report that on your standard individual tax return (form 1040).

Don’t Be Afraid to File Sole Proprietor Taxes—or Get Help!

Hopefully, this article made tax on sole proprietorships feel like one more totally-manageable to-do to tackle for your business, but if you’re still feeling overwhelmed (or just want to make sure you don’t mess anything up), consider hiring an accountant to help. There are so many CPAs who specialize in helping entrepreneurs like yourself—plus it’s just another expense you can write off for your business!

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This article is not intended to be financial advice.