How to File Taxes for a Sole Proprietorship - The Ultimate Guide

Min Read

Tom Smery

Sole proprietorships represent a good way to get yourself into the business field, without necessarily opening a corporation - but like with every business, you need to find out how to file taxes for a sole proprietorship. So, what are the rules that you need to follow?

Sole proprietors have their own tax advantages, and filing a personal tax return is a relatively easy process. However, you still need to learn more about the forms and technicalities. This guide should give you all the information that you need in that regard.

Note: If you are a sole proprietor that needs help with managing your self-employment taxes and tracking all your receipts for deductions, try Bonsai Tax. Our app could scan your bank/credit card receipts to discover all your potential deductions at the push of a button. Users typically save $5,600 from their taxes. Claim your 14-day free trial today.

What Are Sole Proprietorships?

Sole proprietorships represent one of the most common business structures, and perhaps the easiest to establish. To put it simply, when it comes to sole proprietorship taxes, there is no distinct line between you and your business. The Internal Revenue Service (IRS) will treat you as the same entity.

A sole proprietorship is unincorporated, which means that you will receive all your business income under your own name. That being said, you will also be responsible for the taxable income, and you will be the one who needs to handle the estimated taxes. In other words, since you are sole proprietor paying yourself, you will be subjected to income tax liability.

If you go into debt, you'll also be responsible for paying it yourself - whether you have the money or not. For instance, if you go bankrupt and you do not have the means to pay it, then the IRS will be able to seize your personal assets.

At the same time, with a sole proprietorship, you get full control over every business decision that you make. Also, you do not have to get a special license either, and the tax payments are much easier to go through - mainly because you do not need to file as much.

What Sole Proprietorship Taxes Do I Have to File?

Sole proprietorships are referred to as "pass-through entities," which means that all the business income and taxes are "passed through" to the owner. You will be the one to report the income on your personal tax return, and you won't have to set up a licensed business or corporation for that.

For the most part, this will reduce the paperwork that you need for your annual taxes. With that in mind, there will still be a couple of business taxes that you will have to deal with, including:

Federal Income Tax

When it comes to federal income taxes, self-employed individuals have to file two forms. The first form they will need to complete is form 1040, which is their individual tax refund.  After that comes Schedule C, which contains the profits and losses of the business.

To put it simply, form 1040 will report your personal income, whereas Schedule C will be reporting the income of your business. When you pay federal income tax, you need to put your taxable income on both documents.

The amount of tax that you owe will be a mix of income between the two. If your income tax is assessed by the state, then they will pull the numbers from your federal tax, to see exactly how much you are due. Your liability is determined based on which tax bracket you land into.

State Income Taxes

When you file for federal income tax, you may need to file state income taxes as well. This is not a necessity, and in some states, you may not even have to pay this tax at all. However, if state income tax is, after all, required in your place of business, then you will have to file it using form 1040 and Schedule C.

Self-Employment Tax (Social Security and Medicare)

Self-employment taxes are also something that you will now have to pay by yourself. When you are under someone else's employment, they will be responsible for handling your Social Security and Medicare taxes. However, sole proprietors must handle that tax themselves - plus the tax that is typically paid by the employer.

When calculating your self-employment taxes, 12.4% of it goes into Social Security, whereas 2.9% goes into the Medicare tax. Put together, your self-employment tax rate is 15.3%, which will be taken out of your gross business income. Depending on the business you are running, or whether you are filing jointly or not, you may or may not have to pay some additional fees to your self-employment taxes.

Aside from filing Schedule C and 1040 tax forms, you will have to file Schedule SE as well. This form is designated to those who are self-employed, and will be necessary in order to deduct half of your self-employment tax.

Sales Tax

This tax will apply if you sell services or products. If you are selling a product or offering a service to someone, then you need to pay the sales tax as well.

Bear in mind that how sole proprietors pay or collect this tax will depend mostly on the state. In some cases, it may join your estimated taxes, whereas in other states, it may not have anything to do with you at all. You may want to check with the Department of Revenue from your state, to see whether you have to pay this tax or not.

Estimated Taxes

Depending on the case, you may have to file estimated taxes as well. These can be both federal and state taxes, but unlike your usual yearly taxes, you pay an estimated fee ahead, by a certain set deadline.

These taxes are due on a quarterly basis, meaning that you will only pay about 25% of what your yearly tax is going to be. Typically, these taxes are filed using form 1040-ES, and you must be certain that you estimated the correct amount of your taxable income.

Sole proprietors are advised to make sure they pay the correct amount and are not underpaying. They could always pay more and then receive the rest back on their tax refund. However, if they pay less, they might just end up having to pay an underpayment penalty as well.

Property Taxes

Sole proprietors that own property might also have to pay property taxes. This is a local tax for the most part, and how much you pay will depend on your location.

When Should I File Sole Proprietorship Taxes?

You should file sole proprietorship taxes the moment you begin getting net business income from your activity. With that in mind, you will not have to file each separate receipt from the moment you receive them. You simply have to gather them, and then file by the given deadlines of the IRS.

Depending on the type of tax that you are filing, the chances are that you need to make estimated tax payments on a quarterly basis. The deadlines to file quarterly taxes are typically April 15, July 15, October 15, and January 15.

Dates typically remain the same throughout the years, around the 15th of the month, but they may change depending on whether  it is the weekend or a bank holiday. If the deadline falls on such a day, then it will be pushed onto the next working day.

Bear in mind that the IRS expects you to make all of these payments throughout the year. This means that you need to complete Schedule SE as well, in order to determine just how much you will have to pay. If you fail to pay on a quarterly basis and decide to only make the payment upon your annual tax refund, then you risk receiving a penalty.

How Much Do You Have to Make to File Taxes as a Sole Proprietor?

As the owner of a sole proprietorship, you will be treated in the same way as a self-employed individual in terms of taxes. As a result, if you make more than $400, then you will need to pay your taxes and file an income tax return.

Still, this does not mean that if you make less than $400, you won't have to file an income tax return. You still do. The only difference is that you do not have to pay as much when it comes to taxes.

To put it simply, when you are paying taxes, you are actually paying for the profit that you make through your sole proprietorship. If you don't make any profit (i.e., all the business income goes on buying new gear and materials), then you won't have to pay any extra fees. You'll just have to file for tax return when the time is due.

Note: if you want to try the best tax software for professional business owners, use Bonsai Tax. Our app sends you filing reminders, estimates your tax bill and tracks all your receipts automatically. In fact, users typically save $5,600 from their taxes with our software. Claim your 14-day free trial today.

Can a Sole Proprietor Get a Tax Refund?

Yes, as a sole proprietor, there are several circumstances in which you can get a tax refund for certain business expenses. They can reduce your income taxes, reduce your tax liability, and actually help you increase your profit rate. Here are the categories that you may deduct as a sole proprietor.

If you want to manage your deductions easier, we recommend you open a business bank account for sole proprietorship.

Health Insurance Premiums

Many sole proprietors do not seem to realize that they can get a tax refund for their health insurance premiums, as well as for their families, without having to categorize them as itemized deductions.

At that point, your health insurance premium will be labeled as an "above the line" tax refund, meaning that you may easily deduct it before you even reach an adjusted gross income.

You'll want to make a note that this only applies for the months when you, as well as any other member of your family, are not covered by group insurance. If that's the case, then you may not be able to get your business deduction.

Home Office

Very often, sole proprietors refrain from claiming home office deduction, because they believe it to be a red flag that may trigger an audit. Still, if you are a sole proprietor and you run a business from home, then you are actually entitled to get this deduction.

This deduction can be great for your tax liability. You can deduct the mortgage or rent on your home, the part that you use for business. The only condition is that this part of your home must be used exclusively for work. So, if you usually do your work on the kitchen table when you aren't cooking, then you will not be able to get this kind of tax refund.

Try our free worksheet to track home office expenses.

Business Mileage

Depending on the nature of your business, you may or may not have to drive to certain locations. Perhaps you constantly have to go get supplies, or you frequently have to meet with your clients or partners.

The mileage rate for 2022 is 58.5 cents, so you may want to base your calculations on this. The mileage rate changes from year to year, so you'll want to keep an eye out.

For you to get this tax refund, you'll need to keep mileage records. Thankfully, since we now live in 2022, there are countless business apps that can help you in this case. Or you may go the old-fashioned way, marking the miles and saving them/taking a picture of them. Try Bonsai's free template to track mileage.

Self-Employment Tax

When you are under someone else's employment, your employer will pay half of your Social Security and Medicare taxes, whereas the other half will be withheld from your income.

As a sole proprietor, you are a self-employed person - and therefore, you are responsible for paying the full self-employment tax. The self-employment tax rate for 2022 is 15.3%, which means you will have to put aside half of your net earnings in order to make that payment.

Normally, you'd have to pay yourself the part that your boss paid for you. However, as a sole proprietor, you may deduct half of that self-employment tax yourself. When your tax refund is finalized, it will feel like you are still under the benefits of employment, but working for no other person than yourself.

Telephone and Internet

Depending on the kind of sole proprietorship that you own, you may have to use your telephone or the Internet a lot. As an individual, you will pay taxes for it anyway. However, as a sole proprietor, you may be able to get a separate business tax return. Bear in mind that you will only get tax deductions for the percentage that you use for work only.

Do I Need to File a Tax Return for a Sole Proprietorship with No Activity?

If you are a sole proprietor, but your business has no activity that year, then it is not necessary to file Form 1040, Schedule C for profit and losses. You only need to file if your business brings revenue - so, if it doesn't, then there's no need for that.

The only exception is if you are a single-member LLC - which is similar to a sole proprietorship, but on the paperwork, it really isn't. Even if you may not have specific payments to report, you have to pay certain taxes and fees as an official business entity.

The Bottom Line

As a sole proprietor, you need to pay taxes just like every other business owner. It is important to keep your personal and business finances separate for taxes. If you file your taxes right, then you may also be able to take advantage of deductible business expenses.

Your business may not necessarily have a special license, but when it comes to taxes, you get the same advantages that a self-employed business owner would.

Tom Smery
Tom Smery is a certified CPA for over a decade. In his free time, he writes articles to pass on his expert knowledge on taxes and accounting. Thomas has a wide range of deep knowledge on 1099 taxes, and finance topics. You can find him fishing when he is not preparing taxes for his clients or writing about accounting.

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