Taxation of Sole Proprietorships
UPDATED: February 6, 2019
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The IRS does not distinguish between the owner of the sole proprietorship and the business entity, meaning that they are taxed as one and the same. This is often called "pass through" taxation, because the sole proprietorship taxes pass through to the owner. This makes taxation of a sole proprietorship into a fairly simple process because the owner can include business profits in the personal income tax return by using the 1040 form.
Sole Proprietorship Taxes and the Schedule C
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 revenue will determine your net loss or profit for the tax year, which is entered on line 29 of Schedule C.
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 a percentage of expenses for meals, as long as they are business-related. (Starting 2018, the deduction for any expenses related to entertainment, amusement or recreation is gone.) 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 be deducted from any regular salary or wages that you and your spouse have earned during the year.
Self-Employment Tax & Your Sole Proprietorship
Another requirement of sole proprietorship taxation is the self-employment tax. The self-employment tax is based on your net profit for the year as reported 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 as if you had been a wage earner because these are mandatory payroll taxes that every wage earner must pay if she or he earn an income. Generally, for those taxpayers that are employees, their employers pay half of the Social Security and Medicare taxes on earnings while employees pay the other half throughout the year through payroll deductions.
However, as the owner of a sole proprietorship, you are both the employer and the employee so you must pay the entire amount of Social Security and Medicare taxes. For 2018, the self-employment tax is 15.3% of net profits.
Filing Your Sole Proprietorship Taxes
If you own a sole proprietorship, there are steps that you can take throughout the year that will make tax time easier.
First, to avoid facing a huge annual tax bill that you cannot afford to pay all at once, consider making quarterly payments to the IRS. Estimate the amount of taxes that you think you will have to pay at the end of the year and submit portions of this amount throughout the year to reduce your liability. By making quarterly estimated payments, you can also avoid underpayment penalties and interest charges from the IRS.
Second, keep your business expenses separate from your personal ones by maintaining a separate business account and using business checks. Business credit cards used exclusively for business related expenses can help track large purchases.