The IRS does not distinguish the owner of the sole proprietorship from the business entity, meaning that they are taxed as one and the same. This is often called "pass through" taxation, since the sole proprietorship taxes pass through to the owner. This makes taxation of a sole proprietorship into a fairly simple process because, as the owner, you can include your business profits on the usual 1040 form you fill out every year.
One of the main differences between filing your regular income taxes and filing the taxes for your sole proprietorship is the Schedule C form. Schedule C is the IRS form that will accompany your 1040 form when you file taxes for your sole proprietorship. The Schedule C form is self-explanatory, and easy to fill out. You will simply list all of your business expenses for the year, followed by your business profit for the year. The difference between your expenses and profits will determine your net loss or profit for the tax year, and will be entered onto your 1040 tax form.
There are many different items that can be listed as business expenses as you file your sole proprietorship taxes. Some of these include operating expenses, travel expenses, equipment and product costs, advertising expenses, and even expenses for meals and entertainment, as long as they are business-related. Any net profit on Schedule C will be subject to the normal income taxes on your 1040 form. If your business experienced a loss, this will not be taxed, and instead deducted from any regular salary or wages that you and your spouse have made during the year.
Another requirement of sole proprietorship taxation is the self-employment tax. The self-employment tax comes off the top of your net profit for the year on your Schedule C. The IRS has a form to use for this tax as well, called a Schedule SE. The self-employment tax covers Social Security and Medicare taxes, taxes you would otherwise be paying through your employer. Generally, your employer would pay half of the Social Security and Medicare taxes on your earnings, and you would pay the other half, every paycheck. However, as the owner of a sole proprietorship, you are both the employer and the employee, and must pay the whole thing. For 2011, the self-employment tax went down 2% from the last few years, and is now 13.3% of your net profit.
If you own a sole proprietorship, there are a few steps that you can take throughout the year that will make tax time easier. Start making quarterly payments, and keep your business expenses separate from your personal ones. Because you don’t pay taxes throughout the year, as you do as an employee of another business, you must get used to setting aside money to pay for taxes. You can do this by estimating the amount of taxes you will pay at the end of the tax year and making quarterly payments to the IRS.
This way, you are not faced with a huge annual tax bill that you cannot afford to pay all at once. While you may be able to pay your sole proprietorship taxes on an end-of-the-year tax bill, remember that the IRS will charge you interest on the amount you owe them until you are paid off. You can keep your business finances separated from your personal ones by maintaining a separate business account and business checks for your sole proprietorship, as well as having a business credit card handy for larger purchases.