Businesses filing taxes as a sole proprietorship are the most common in the United States. In 2015, the Internal Revenue Service estimated more than 25 million sole proprietorships in the country.
This doesn’t come as a surprise since establishing a sole proprietorship (with one single owner) is very easy: if you manage an unincorporated business and you are its sole owner, you have in fact a sole proprietorship.
Legally speaking, remember that having a sole proprietorship implies your company is legally linked to your person. This means that you must report the income and losses of your business on your personal tax return. If this is the first time you submit taxes as a sole proprietor and you feel unsure about the process, this complete guide will help you.
All you need to know to file taxes as a sole proprietorship
You must file an annual tax return, reporting information about you and your company. This is what you need to know to prepare it properly:
What documents do you need to gather?
You need to gather both personal and business documents:
- Personal documents: Social Security Number (or in lieu, your ITIN) and receipts to support any deduction, such as payment stubs of your mortgage or student loan. You must also submit other tax records, such as proof of payment of property taxes, state or local taxes.
- Business documents. Gather any documents showing your business expenses, such as utility bills and rent, or receipts for purchases of supplies and equipment. You may be able to deduct some of these expenses, and thus decrease the amount of your annual taxable income. Later we will explain what deductions you can claim in your tax return.
What forms do you need to submit?
- Schedule C. Sole proprietors must report their income and expenses using this form. Schedule C-EZ is simpler: it is used when a business doesn’t have employees and reports less than $5,000 in expenses.
- Schedule SE. Every employee must pay half of the cost of their Social Security and Medicare, and the employer must cover the rest. As a sole proprietor, you must pay both items, which is equivalent to 15.3 percent of the net profits of the business. This form is used to calculate the total amount. However, half of this tax can be deducted from your income.
- Form 1099-MISC. If you hired a contractor temporarily, paying for their services more than $600 during the tax year, you must file a Form 1099-MISC. One for each contractor or freelance is required.
- Form 1099-K. This form reflects income from a third-party, transactions made with credit and debit cards, and payments made with PayPal. You must fill out this form if you sell items online.
You may have to file other forms with the IRS if your business meets certain special conditions.
Can you claim deductions?
If you have a sole proprietorship you may be entitled to some deductions that will help you reduce your taxable income.
These deductions are made on expenses recognized by the IRS as “ordinary and necessary,” which means they must be common, useful, and aligned with the goals of your business. These are some of the most common deductions for sole proprietorships:
- Health insurance. If you are a sole proprietorship, you can deduct the premiums from your health insurance. This deduction is especially valuable since it can reduce your adjusted gross income, and help you qualify for other credits or deductions.
- Mileage. If you use your vehicle to work, the mileage deduction can have a considerable impact on your tax obligations. To deduct this cost, you have to keep track of the miles covered. This can be done using applications for smartphones.
- Home office. If you use a space in your home for business purposes, you can deduct some expenses for the commercial use of your home. This deduction is available for both owners and tenants and applies to all types of homes.
- Deductible taxes for independent workers. As mentioned before, when filing taxes as a sole proprietorship, you must pay 100 percent of your Social Security and Medicare. Luckily, 50 percent of this tax is deductible.
- Deductive tax deduction of 20 percent. The 2017 Tax Cuts and Jobs Act, also known as Trump’s Tax Plan, provides in Section 199 a tax deduction applicable to the 20 percent of the business’s net income. Although this can mean a generous deduction, not all sole proprietors can access this benefit –later we’ll see why.
Deadlines for filing taxes as a sole proprietorship
Sole proprietorships must file their taxes before April 15th, unless they request an extension: in that case, they are allowed to submit taxes until October 15th (but make sure to request the extension before April 15th!)
This is different when it comes to paying taxes. The IRS requires tax obligations to be paid during the tax year. As a sole proprietor, you are required to pay taxes quarterly.
The IRS expects you to pay the same amount each quarter, but if your business income is not stable or is seasonal, payments may vary depending on fluctuations on your income. Failing to pay your business taxes on time could cost you dearly. In addition to the fines, you will have to pay accrued interests.
Pros and cons of declaring taxes as a sole proprietorship
This is the simplest way to manage a business, and therefore, filing taxes is also simpler and relatively easy. A sole proprietorship is considered as a transfer entity, meaning that the business benefits transfer directly to the owner, who has to report the business’ income and losses on his personal tax return. Being a sole owner, you don’t need to calculate property or stock percentages. After paying taxes, all the profits are yours.
The percentage of taxes that a sole proprietorship has to pay are usually higher than for other types of business structures. Although many sole proprietorships have a 20 percent tax deduction, this type of business usually ends up paying more than corporations and LLCs.
This is because not all companies are entitled to this deduction of 20 percent since this reduction decreases as your income increases. If you don’t have employees or commercial property that can be depreciated, you are not entitled to this exemption either.
In addition, sole proprietors may end up paying more money to Social Security and Medicare. These taxes on self-employment are calculated on the total income of the company, and the larger your benefits, the more you have to pay.
Learn how to file taxes if your small business is a corporation, a Limited Liability Company or if you are a sole proprietor.
Filing your taxes can be stressful, but doing it on your own is not impossible. Prepare in advance: make sure your records are up to date and accurate, save all your receipts, and gather all the documents necessary. Also, keep in mind that if you don’t pay your taxes on time, you may be subject to fines and other penalties.
If all this process is overwhelming, or you just don’t have the time to do it yourself properly, you can consider several options to help you file your taxes. We recommend you to hire a professional accountant who can tell you all the forms you need, the deductions you are entitled to and provide you additional advice.
Remember, a tax return that reflects inaccuracies and mistakes can not only hurt your business but also increases your chances of an IRS audit.
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