Tax Guide for Solopreneurs

How to do My Taxes as a Sole Proprietor

Starting your own business may be a dream come true. You’ve started the business you’ve always wanted, but now you have to deal with the taxes.

Just like when you worked for someone, Uncle Sam wants his piece of the pie, only this time, you’re responsible for a lot more than just the employee side of taxes. Because you are the employer and the employee, you pay both sides of the taxes.

It sounds overwhelming (and expensive), but if you know what to expect, you can plan for your tax liability and even minimize it and confidently say ‘I know how to do my taxes.

Here’s what you must know.

Who is Considered a Sole Proprietor?

Sole proprietors are single owners of a business. Most sole proprietors aren’t registered with the state, and many operate their business in their personal name. There are some sole proprietors who have form an LLC. A single member.

When you operate a sole proprietorship, there’s no distinction between you and the business. You are the same both legally and for tax purposes. This means you are responsible for all liabilities and even lawsuits, just as you’re responsible for all taxes.

The IRS considers sole proprietors a ‘pass-through’ business which means the money you earn (or lose) passes through to your individual tax return. You must report the income on your tax return and pay the applicable taxes throughout the year.

How are Sole Proprietors Different?

There’s one large distinction between sole proprietors and any other business type – ownership.

You (the owner) and the business are one. If the business loses money, you lose money. But if the business makes money, you make money and owe the taxes on that money, in addition to any other income you’ve earned in other areas.

Because the income becomes a part of your personal income, you’re responsible for all aspects of taxes including:

• Federal income tax

• Self-employment tax (Medicare/Social Security)

• State taxes (if applicable)

• Sales taxes (if applicable)

This differs from when you work for someone. When you work for an employer, they pay half of your Medicare and Social Security tax, leaving you with only 7.65% tax liability versus 15.3%.

How are Sole Proprietors Taxed?

Sole proprietors must report all income on their personal tax returns. You don’t have to file business tax returns, which may make tax preparation easier, but it’s important to know how sole proprietors are taxed.
Federal Income Tax

All sole proprietors pay federal income tax on the business income earned. You calculate your income on Schedule C, which is a schedule added to your personal tax return.

On Schedule C, you’ll disclose your business’s income and expenses. You’ll also disclose the cost of goods sold, and any expenses you incur if you operate a home-based business. You must then report the net income calculated on your Schedule C on the first page of your 1040.

The net business income gets figured in with any other regular income you and your spouse earn. If your business has a loss, it will decrease your adjusted gross income and your tax liability. If your business has a profit, it will increase your adjusted gross income and taxes owed.

You pay the current tax rate based on your income for the year on all income reported in your adjusted gross income.

Self-Employment Tax

Self-employment tax is the portion of taxes your employer typically paid. Since you are the employer and employee now, you must pay both sides.

The self-employment tax covers your Medicare and Social Security taxes. If you don’t have any business income for the year (you have a loss), you won’t owe self-employment taxes. However, you also won’t get a Medicare or Social Security credit for the year either.

Currently, the self-employment tax is 15.3% - 12.4% of it is Social Security and 2.9% is Medicare. You report self-employment tax on Schedule SE, alongside your Schedule C.

Sales Tax

If you live in a state that charges sales tax, you pay sales tax on all goods and services sold. You may also be responsible for excise taxes. Always check with your bookkeeping provider or state department of revenue to determine if you should collect (and will owe) sales tax.

Property Tax

If you own any property, or you use your home as your office, you’ll also owe property taxes on the property. The amounts, due dates, and liabilities vary by state.

How to File Taxes as a Sole Proprietor

As a sole proprietor, you’ll complete different tax forms than you would as an individual. Here’s what you must know.

• Complete Schedule C

Schedule C is where you report your business income and expenses. In its five sections, you’ll report:

• Income

• Expenses

• Cost of goods sold

• Vehicle expenses (including mileage)

• All other business expenses

• Complete Schedule SE

After you complete Schedule C, you can complete Schedule SE. You’ll use the business income calculated on Schedule C to determine your self-employment tax liability. However, you’ll be able to deduct ½ of your self-employment tax on your 1040.

• Pay your estimated taxes

This is where sole proprietorship taxes differ the most. Because the United States is a pay-as-you-go tax liability country, you must pay your taxes as you go too. Since you don’t have an employer withdrawing taxes on each payday, you’re obligated to file your estimated taxes every quarter (every four months).

Your estimated taxes are due April 15, June 15, September 15, and January 15 each year. If you pay within $1,000 of what your tax returns show when you file your taxes for the year, you won’t owe any late payment or underpayment penalties.

Frequently Asked Questions about How to do my Taxes as a Sole Proprietor

What tax deductions can sole proprietors take?

Sole proprietors can write off expenses that are ordinary and necessary for their business. Each business has different deductions, but here are some of the most common:

• Home office space or office rental

• Health insurance for you, your spouse, and any dependents

• Vehicle use

• Advertising

• Supplies

• Equipment

• Meals for clients

• Internet and phone bills

What is the pass-through deduction?

The pass-through deduction allows you to deduct 20% of your business income on your 1040. This lowers your income tax liability, but not your self-employment tax liability. For example, if you pass through $40,000 in business income, you can deduct $8,000, paying taxes on $32,000 versus $40,000.

When do you file sole proprietor taxes?

You file your business taxes at the same time you file your individual taxes – by April 15th of each year. If you can’t file your taxes by that date for some reason, file an extension, but do your best to pay your tax liability. If you paid your estimated taxes on time, you shouldn’t have much to worry about, but always check with your tax preparation service provider to be sure.

Do sole proprietors pay taxes on losses?

No, just like you can offset your investment income with a loss, if you have a business loss, it offsets your adjusted gross income, lowering your tax liability. 

Tips for Sole Proprietor Tax Preparation

Tax preparation can seem scary, but with the right steps, anyone can do it. Here are a few quick tips to keep you organized.

• Keep receipts for all expenses. Any expenses you plan to write off needs documentation.

• Apply for a free Tax ID number so you don’t have to give vendors your Social Security number.

• Prepare a separate space in your home exclusively for your business so you can write off your home office expenses.

• Keep track of your estimated tax due dates and amount owed, making your payments on time.

Final Thoughts

If you ask ‘how do I do my taxes if I’m self-employed?’ it’s not as overwhelming as you think. Getting support is always key, but know that you can make the most of owning your own business.

The Pass-Through deduction was created to encourage more people to start their own business and with the state of today’s economy and society, starting your own business isn’t a bad idea!

There are many ways to ensure you stay on top of your tax liability and don’t get swallowed up by the taxes you owe versus what you make. Working with a qualified tax professional or bookkeeping professional is the best way to ensure you stay organized, on top of the latest regulations, and make the most of your business income.