Federal, state and local agencies impose recordkeeping and filing requirements for all businesses. Fortunately, tax filing can be far simpler for sole proprietorships, especially those with no employees, than for other business legal structures. With a basic understanding of local, state and federal requirements, you can stay on top of your sole proprietorship’s tax obligations.
If your activity’s primary function is to generate income or profit and is conducted “with continuity and regularity,” the Internal Revenue Service considers it a business.
Choosing a business legal structure is an important decision when you’re starting a business. A sole proprietorship is the simplest small business structure. It’s the form your business takes by default. If you own and run a business by yourself and haven’t chosen another business structure, such as a corporation, you are a sole proprietor.
If your business is a limited liability company (LLC), you may qualify to file your tax returns as a sole proprietor if you meet specific criteria.
When filing taxes, sole proprietors have it relatively easy compared with corporations, partnerships and other business legal structures. Most businesses must file separate, often lengthy reports with the IRS, including balance sheets and equity details. In contrast, a sole proprietorship may need to file as little as two pages to report business income and expenses.
Here are some key aspects of preparing and filing your taxes as a sole proprietor:
When starting a sole proprietorship, you’ll need to decide if you want to use your personal name or establish a DBA (doing business as) name.
If you’re new to paying taxes as a sole proprietor, you may be surprised at the amount you owe in Social Security and Medicare taxes, also called self-employment taxes. Employees pay half of their Social Security and Medicare tax, and their employers pay the other half. In contrast, self-employed individuals who make a net profit of more than $400 per year must pay the entire tax themselves.
The self-employment tax rate is 15.3 percent of net income from self-employment, with 12.4 percent going to Social Security and 2.9 percent going to Medicare.
As a sole proprietor, your self-employment tax costs may often exceed your income tax bill. Plan ahead so your tax bill doesn’t take you by surprise.
One of your most important tax obligations as a sole proprietor is to determine whether you must make estimated federal and state income tax payments quarterly. You must pay quarterly estimated tax if both of the following statements are true:
You can use IRS Form 1040-ES to estimate your required payments. However, using tax software is easier and more accurate. Your tax software’s business module typically uses the current year’s information and asks additional questions to calculate the amount of estimated tax you should pay. It even prepares vouchers to print and mail with your payments.
Your estimated tax payments for the tax year are due on the following dates:
If the date falls on a weekend or holiday, the payment is due the following business day.
Tax benefits can go a long way in reducing your business’s tax liability, especially when you’re a sole proprietor. Some credits and deductions available to all business types include the following:
Tax deductions are crucial. Every dollar you deduct as a business expense saves you about 15 cents in self-employment tax. That’s in addition to potentially lowering your federal and state income tax bills.
The secret to keeping up with your taxes — and paying as little tax as legally possible — is to plan and organize ahead of time. The tax filing requirements for sole proprietorships are more straightforward than those for corporations, partnerships and other types of business structures.
With basic planning, an organized recordkeeping system and good tax software, you’ll ensure that filing your taxes as a sole proprietor won’t keep you away from the crucial work of succeeding at self-employment.
Andrew Martins contributed to this article.