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Posted by Tiffany Gaskin

How a Sole Proprietor Pays Income Taxes & Other Taxes

How a Sole Proprietor Pays Income Taxes & Other Taxes

A sole proprietorship is the default business type because most businesses begin that way.  Sole proprietorships are taxed differently from other kinds of businesses because they are unique. 

One major thing to note about the taxation of businesses owned and operated by a sole proprietorship is that the businesses aren't taxed separately.  There's no separation between the owner of the company and the business being a sole proprietorship.  And this applies for both tax and legal purposes.  A Sole proprietor is a one-person owner of a business not registered with the state.  That is why the business taxes are not separate from the owner.

Instead, a sole proprietor must file all profits and losses in the personal income tax returns.  That's the main distinction between a sole proprietor's reporting income as an earner of wages.

Along with Form 1040, a sole proprietor must also submit a statement of the business's profit and loss on Schedule C to the IRS.  This account of income or loss is entered on Line 31 of the schedule.

So as a sole proprietor, your personal income taxes and other taxes have their uniqueness.  Let's look at them in detail.

 

How Sole proprietors pay income taxes

Remember, no one employs a sole proprietor, so they don't "receive" paychecks, and as such, their taxes can't be withheld, as is the case with paid employment.  So, the sole proprietor should know how to estimate how much is due from the business's income and make quarterly estimated payments to the IRS.

When a sole proprietor reports profits and losses, the business is taxed on all the profits.  The profit is calculated when expenses used to run the business are deducted from the income. 

Sole proprietors are allowed to deduct business expenses and not just the cost of production.  Any expense that was used to increase profit is deductible.  These may include advertising costs, business-related travel, logistics, equipment, assets, and even meals.

As long as the funds were spent to increase profit, it is part of the business expense and can be deducted from the income before tax. 

Recently passed legislation also allows sole proprietors to deduct up to an additional 20% of the total income as a personal deduction, although the income shouldn't exceed $207,500.  Also, if your income exceeds $157,500, you must have employees benefit from the additional deduction.

 

Self-employment tax for sole proprietors

Another way sole proprietors pay taxes is through self-employment taxes, similar to payroll taxes paid by employees.  As a sole proprietor, you must contribute to Social Security and Medicare if your business earned at least $400 in revenue. 

These contributions are deducted from employees' salaries, but since no one can deduct them from the income of the sole proprietors, they have to do it themselves. 

Self-employment taxes must be reported on Schedule SE, which is submitted alongside the annual tax return (1040) and Schedule C.

When sole proprietors pay their income taxes, they must make these contributions equal to 15.3% (12.4% for Social Security and 2.9% for Medicare).  Employees only have to pay half of this for Social Security and Medicare because their employers have to pay a matching amount.  Still, the self-employed and sole proprietor has to pay the entire amount.

However, if the business has run at a loss during the business year, there is no requirement to pay the self-employment tax.  The caveat, however, is that the business owner can't receive benefits from Social Security and Medicare for that year.


Other taxes

The sole proprietor must pay property taxes if he owns a building or a landed property.  This tax rate is dependent on the location of the building.  If the business involves the sales of products, the sole proprietor is not exempt from sales taxes of products sold.


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Tiffany Gaskin
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