Introduction
Working as a sole proprietor, whether as a freelancer or an LLC owner, brings numerous benefits, like increased flexibility and the ability to pursue one's passion. However, it’s no secret that the main downside to working for oneself is the burden of tax season. Independent tax filing for a sole proprietorship can be complex, with varying IRS regulations, deductions, and forms required — all of which individuals are solely responsible for correctly completing.
However, filing taxes as a sole proprietor can be easy. Let’s prepare to report and pay your taxes with ease by going over the IRS guidelines for filing sole proprietorship taxes, the specific forms you need, and filing as an LLC owner.
What is sole proprietorship taxation?
According to the IRS, a sole proprietor is an individual who owns an unincorporated business by themselves. A sole proprietor may look like a freelancer or LLC owner who provides services to clients. Working for oneself, a sole proprietor is solely responsible for filing their tax returns each year. Sole proprietorships are taxed as personal income, meaning the owner pays taxes on the business's profits. Like with income tax, the amount of tax owed will depend on the individual’s marginal tax rate, which is the rate at which their last dollar of income is taxed.
This type of taxation is called "pass-through taxation," as the income passes through one’s business to their income, and thus their income tax return. Pass-through taxation is filed using forms Schedule C and Form 1040, in addition to any other forms that may apply to each type of work. Taxes for sole proprietors are calculated based on one’s net income or the income after the cost of goods, expenses, and appreciation/depreciation.
As sole proprietors do not receive tax deductions from payroll like traditional W-2 employees, they must pay the total amount of taxes due themselves each year or quarter. To account for this, most sole proprietors set aside enough earned income throughout the year, with some set aside extra for added security. Sole proprietors may also pay their taxes in quarterly installments and file an estimated tax return in advance of the typical tax return due date.
With sole proprietorship taxation, the individual is also responsible for contributing to their social security funds at the sum of the rate for both a traditional employee and employer since they do not have an employer to contribute on their behalf. Let’s review exactly how sole proprietors are taxed by the IRS below.
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How are sole proprietors taxed?
As we mentioned, sole proprietors are taxed as individuals, meaning their business income is taxed as personal income, and they are fully responsible for filing said taxes. As a general overview of how sole proprietors file taxes, sole proprietors must:
- Determine their taxable income
- Deduct business expenses from their business income, which can lower their overall tax liability
- File a personal tax return using Form 1040 and Schedule C
- Pay self-employment tax on their business income
Sole proprietors file personal income tax returns using Form 1040 and report their business income on Schedule C. Individuals must determine their taxable income by subtracting expenses from total income. Thus, one’s sole proprietorship income is taxed based on net income.
In addition to calculating net income, sole proprietors can deduct business expenses from their taxable income. Some business expenses, such as business meals, may be 50% deductible, while others are 100%. Common deductible business expenses that you should report, if applicable to you, are:
- Health insurance: Self-employed people can deduct health insurance premiums from their taxable income. Only self-employed individuals who pay for a health insurance plan themselves and are not on a partner’s or family member’s employer-provided insurance can deduct this expense. This expense can be reported on Schedule 1 Form 1040, line 17.
- Home office: Sole proprietors can deduct rent for dedicated office space as a business expense; however, this space must be solely used for business activity. Other home office supplies and equipment may also be deducted if used solely for one’s business.
- Business mileage: This expense may also be deducted from one’s taxable income. Depending on one’s business, this can be a hefty deduction, while others may not need to deduct business mileage.
- Self-employment tax: As sole proprietors are typically responsible for paying self-employment tax or taxes contributed to social security and medicare, they may partially deduct this payment from their income tax. The self-employment tax rate is typically 15.3% of one’s net income, but 50% can be deducted from income tax using Form 1040 under “Adjustments to income.”
To plan to deduct business expenses each year or quarter, keep accurate bookkeeping records throughout each period. Additionally, understand that not all business expenses or losses are tax deductible. Many sole proprietors make the mistake of deducting non-deductible costs from their income, such as loan and debt payments. This may result in paying too much or too little in taxes, which you will want to avoid. Also, individuals should understand that not all eligible business expenses are 100% deductible, and some may only be partially deductible. This is important to remember, so there are no surprises when it comes time to pay one’s tax return.
Taxes for sole proprietors are either paid yearly or quarterly. Quarterly payments are required in many circumstances, for which one would file Estimated Taxes using Form 1040-ES. Estimated taxes are often necessary for those who expect to pay more than $1,000 in taxes for the year, so check whether you are required to pay quarterly Estimated Taxes on your sole proprietorship.
What tax forms can you use for your sole proprietorship business?
The tax forms necessary for one’s sole proprietorship business vary from person to person, depending on the nature of one’s work. The most common tax forms used for sole proprietorships are:
In addition, many sole proprietors use the following forms for business expense deductions:
- Schedule 1: Additional Income and Adjustments to Income
- Schedule A (1040 or 1040-SR): Itemized Deductions
To assess which tax forms you are required to use, consult the IRS-provided table for sole proprietorship forms below.
Income Tax
Self-Employment tax
Estimated tax
Social Security, Medicare taxes, and income tax withholding
Providing information on Social Security and Medicare taxes and income tax withholding
Federal unemployment (FUTA) tax
Other possible forms required for your sole proprietorship include the following:
Consult with a tax professional if you have questions about which tax forms to use for your sole proprietorship business.
Things to know about tax forms for sole proprietorship LLCs
Many LLC owners file taxes as sole proprietors, especially when operating independently. A single-member LLC is a "disregarded entity" for tax purposes, associating the business activities with the individual owner. Thus, they will need to follow the same procedure as detailed above. The activities of one’s LLC are generally reported using these sole proprietorship tax forms:
Additionally, LLC owners who are sole proprietors will calculate taxable income, deduct business expenses, pay self-employment tax, and pay estimated taxes, as would any sole proprietor. Working with a tax consultant is an excellent way to ensure one’s LLC sole proprietorship taxes are accurately paid.
Conclusion
Taxes for sole proprietorships can be complex, but resources are available to help you understand and file your taxes correctly. Make sure to keep accurate records of your income and expenses throughout the year so that you can easily fill out your tax form when it comes time to file. Also, remember to take advantage of all deductions and credits you may be eligible for as a sole proprietor.
Filing your taxes correctly is essential in order to avoid penalties and interest charges, so make sure to give yourself plenty of time to complete your return before the deadline. Working with a business partner like Skuad helps businesses build and manage global teams easily, as well as pay and report taxes for one’s business and employees in the United States and beyond. Schedule a demo with Skuad today to see how we can help your business thrive.
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