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Sole Proprietorship Taxes: What You Need to Know

by | Mar 1, 2024 | 2024, Accounting, Small Business, Tax planning, Taxes | 0 comments

Sole proprietorship taxes differ from other business entities, such as corporations, in that the business is not taxed separately from the owner. Instead, you record and pay your single proprietorship taxes on your personal tax return.

To explain, the IRS refers to this sort of taxation as “pass-through taxation” since the tax burden belongs to the business owner and is “passing through” to the business owner’s personal tax return. This implies that you’ll need to fill out a separate Schedule C for your sole proprietorship taxes, which you’ll submit together with your personal income tax form, Form 1040.

Sole proprietorship taxation has a few key ramifications. First, “pass-through taxation” means that the net revenue from your firm will raise your personal taxable income, potentially pushing you into a higher tax band. Second, under sole proprietorship taxation, the income taxes you pay are not considered company costs. Some business owners include income tax payments as costs on their profit and loss statement; however, if you’re a single proprietor, these payments are essentially equity distributions and should not be reported as expenses.

Although you should not report these tax payments as costs, that does not imply your company cannot support them. In fact, you should set aside a percentage of your business’s income to meet sole proprietorship taxes on profits. However, keep in mind that if you withdraw money from your firm to pay your taxes, it will be recorded as an owner’s draw rather than a cost.

Sole proprietorship taxes for LLCs

Furthermore, even if your firm is an LLC, you may still be required to file taxes as a sole owner. Single-member LLCs are taxed like sole proprietorships since an LLC is a state-granted legal entity rather than a federal tax status. If your LLC has two members, it will be classed as a partnership for tax purposes; however, either single- or multi-member LLCs can choose to submit their taxes as corporations by filing IRS Form 8832.

With this in mind, if your company is an LLC and you’re not sure what your tax status is, you should check with your business accountant or attorney, especially if they helped you organize your LLC.

Determining your income tax liability

As previously stated, as a pass-through entity, you will pay income taxes on your sole proprietorship as part of your personal tax returns on Form 1040 Schedule C. To submit this form, you must determine your single proprietorship’s taxable revenue.

Fortunately, you do not have to pay taxes on the entire amount of your sole proprietorship’s revenue. Instead, you will only pay sole proprietorship taxes on your business’s profits. Essentially, you’ll be taxed on all earnings — total revenue minus costs — regardless of how much money you take out of the firm. As a result, your sole proprietorship’s taxable income will be similar to the “net income” or “net profit” figure at the bottom of your profit and loss statement, with a few changes.

You will be allowed to deduct business costs on your return, just like any other firm; however, you must ensure that your accounting is properly managed in order to appropriately report your taxable income and any deductions. A typical error made by sole proprietors is to record cash activity – owner’s withdrawals, cash infusions from loans or investments, and payments on long-term debt — as costs or revenue on their profit and loss statement when these activities have no influence on taxable income. These wrongly reported transactions will affect your profit estimate, causing you to pay either too much or too little in sole proprietorship taxes.

Also, while you can deduct your company costs, not all of them that are appropriately recorded on your profit and loss statement are fully deductible. For example, business dinners are only 50% deductible, and beginning with the 2018 tax year, entertainment costs are not deductible at all. As a result, even if these costs appear on your profit and loss statement, keep in mind that they may not have a full impact on your taxable business revenue.

Sole proprietorship taxes: Special deductions

On the other hand, although some cash activity in your firm has no influence on your sole proprietorship’s taxable income, certain non-cash activity can lower your taxable income – yet these activities may not appear on your profit and loss statement.

When it comes to your single proprietorship taxes, you’ll want to keep these unique and sometimes neglected company tax deductions in mind, as they can have a significant influence on your tax obligation.

Health insurance deduction

Many sole proprietors are unaware that they can deduct health insurance costs for themselves and their family without filing an itemized tax return. If you are a single proprietor, your health insurance premiums are a “above the line” deduction, which means you can deduct them before you calculate your adjusted gross income. You should keep in mind, however, that this only applies to the payment for months in which you (or your spouse or other family members) are not covered by a group health plan.

Business mileage

Although the business mileage deduction is not restricted to sole proprietorships, sole owners sometimes disregard it, believing it is negligible. However, if you use your automobile for business reasons, this deduction, at 57.5 cents per mile (in 2020), might have a significant influence on your tax bill. To claim this deduction, you must keep detailed mileage records; however, there are a variety of online business tools that may aid with this process.

Home office deduction

Many sole proprietors are hesitant to take the home office deduction because they have heard it raises a red flag and makes their return more vulnerable to examination. If you run a home-based business, you are eligible for this deduction, which can have a considerable impact on your tax liabilities. However, keep in mind that you can only deduct costs for the portion of your house that is used for commercial purposes. Furthermore, your home office area must be used only for business purposes; if your “office” is a corner of your kitchen table, you cannot claim this deduction.

Self-employment tax

When you work, your employer pays 50% of your social security and Medicare taxes, and the remaining 50% is deducted from your salary. As a single owner, however, you are responsible for all of these taxes. These taxes are known as self-employment taxes, and the current rate is 15.3% on net self-employment income. With that said, 50% of your self-employment taxes are deductible. These unique sole proprietorship taxes are recorded on a separate form, Schedule SE, which we’ll go over in further detail below.

If you want to get the most of your single proprietorship tax deductions, PSACPA is just a phone call away!

Guidance on Filing Taxes for Sole Proprietorships

Considering our prior discussions, let’s delve into the specifics of fulfilling tax obligations for sole proprietorships. While our focus has mainly centered on income tax liability, it’s crucial to recognize potential additional tax responsibilities such as payroll, property, sales, and excise taxes. The IRS offers a comprehensive list of these potential taxes along with the corresponding forms required for each.

Taxation for Sole Proprietorships: Income and Self-Employment Taxes

As previously outlined, sole proprietors report and settle income tax on their business profits by submitting additional forms with their personal return, Form 1040. Typically, sole proprietors only need to file two forms alongside their individual return. Let’s delve into each of these forms in detail.

Schedule C:

Schedule C serves to document the profit and loss of your business, including business mileage. This form is relatively straightforward, divided into sections covering income, expenses, cost of goods sold, vehicle information, and other expenditures. While completing Schedule C, IRS instructions offer guidance, and most necessary information can be sourced from financial statements and mileage tracking apps. Here are a few key points to address:

Accounting method: Choose the cash basis unless advised otherwise by your accountant, ensuring taxation only on received income.

Material participation: Active involvement in business operations warrants a “yes” response; consult with your accountant if your income is passive.

1099 requirements: File 1099s for independent contractors paid $600 or more, with exceptions for payments made via credit card or platforms like PayPal.

The information from Schedule C is utilized to complete your personal 1040 tax form, with the sole proprietorship tax rate aligning with your personal income tax rate.

Schedule SE:

Sole proprietors are accountable for self-employment taxes, akin to social security and Medicare taxes deducted from employee pay. To compute self-employment taxes, first complete Schedule C and then proceed with Schedule SE. Presently, the self-employment tax rate stands at 15.3%, with half deductible on your 1040 form.

It’s important to note that although annual filing includes Form 1040, Schedule C, and Schedule SE, self-employment taxes must be paid quarterly. Form 1040-ES facilitates these estimated tax payments, aligning with IRS due dates.

Additional Tax Obligations

Beyond income and self-employment taxes, other tax liabilities may apply based on your business’s nature:

Employment taxes: Responsible for withholding and reporting taxes for employees, completed through Forms 940, 941, and W-2 (or 1099s for independent contractors).

Property taxes: Mandatory if your business owns real estate or property, subject to local tax regulations.

Sales and excise taxes: State-level obligations for product and service sales, with excise taxes applicable to specific goods like alcohol or tobacco, varying by location.

Filing Deadlines for Sole Proprietorship Taxes

Filing deadlines vary per tax type, with some, like Form 1040 and Schedule C, due annually, while others, like Form 941 for payroll taxes, require quarterly submission. Income taxes for sole proprietorships align with personal tax return deadlines, typically due by April 15, extendable to October 15 with an extension.

However, it’s essential to manage tax responsibilities diligently, making quarterly estimated tax payments through Schedule SE to avoid penalties for late payments or incomplete filings by IRS deadlines.


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