Sole proprietorship taxes: Best tips and tricks for 2025

Of the many business types, such as LLCs and corporations, sole proprietorships are perhaps the simplest. However, filing taxes can still take various steps to complete. 

As a sole proprietor, you are self-employed, so you must report your business income on your personal tax return. Understanding the tax process can help simplify tax time. So, let’s take a look at how sole proprietorship taxes work and how to make tax time less taxing.

How sole proprietorship taxes work

The IRS considers sole proprietorships pass-through entities. This means you file business income on your personal income tax return. There’s no need for a separate business tax return. Sole proprietors report their business income and expenses on Form 1040. Here’s a look at some of the key sole proprietorship tax forms you may need to file:

When filing taxes as a sole proprietor, you must first determine your net profits or losses. Start by subtracting your business expenses from your business income. Your income includes sales, services, or rental activities. Expenses can include home office costs and vehicle expenses.

Self-employment taxes

One of the key aspects of sole proprietorship taxes is self-employment tax. This tax, which funds Social Security and Medicare, is essentially the self-employed version of FICA (Federal Insurance Contributions Act) taxes.

When you work for an employer, you pay 7.65% of your wages for FICA taxes, and your employer matches that amount for a total of 15.3%. This covers both the Social Security and Medicare taxes. 

However, as a sole proprietor, you wear both hats—you're both the employer and the employee. This means you're responsible for paying the full 15.3% self-employment tax on your net earnings from the business.

Estimated tax payments

As a sole proprietor, you might need to pay estimated taxes throughout the year to avoid penalties when you file your annual return. This is because you're responsible for paying your income tax and self-employment tax directly to the IRS, unlike employees who have taxes withheld from their paychecks.

Estimated taxes are essentially pre-payments of your tax liability. You'll generally need to pay them if you expect to owe $1,000 or more in taxes when you file, after subtracting any withholding and credits.

The payment schedule for estimated taxes in 2025:

• 1st Quarter: April 15, 2025 (for income earned January 1 to March 31, 2025)
• 2nd Quarter: June 16, 2025 (for income earned April 1 to May 31, 2025)
• 3rd Quarter: September 15, 2025 (for income earned June 1 to August 31, 2025)
• 4th Quarter: January 15, 2026 (for income earned September 1 to December 31, 2025)

You can use Form 1040-ES to calculate your estimated tax payments. The IRS also has online tools and resources to help. You can pay online, by mail, or by phone.

Additional taxes for sole proprietors

In addition to self-employment tax and income tax on your business profits, you might need to handle other taxes as a sole proprietor. These vary based on your location, industry, and business activities. Here are some common ones:

• Sales tax: If you sell taxable goods or services, you'll usually need to collect sales tax from customers and pay it to your state and/or local government. Sales tax rules are different everywhere, so check the rules in your area.
• Employment taxes: If you hire employees, you'll need to withhold taxes from their paychecks (like income tax, Social Security, and Medicare) and pay your share of those taxes, too. You might also have to pay unemployment taxes.
• State and local taxes: Depending on where you are, you might have to pay state income tax or local business license fees.

It's easy to overlook some of these obligations when you're focused on running your business. A good first step is to check with your state and local government websites for specific requirements in your area.

Sole proprietorship tax benefits

One of the biggest advantages of operating as a sole proprietorship is the simplicity of the tax treatment. This straightforward approach offers several benefits, especially for small business owners and those just starting out. 

Here are some key advantages:

• Pass-through taxation: Your business income and expenses are reported directly on your income tax return (Form 1040, Schedule C). This eliminates the need to file a separate business tax return, simplifying the process and potentially reducing paperwork.
• Fewer filing requirements: Compared to corporations and partnerships, sole proprietorships generally have fewer tax filing requirements and less complex forms to complete.
• Lower administrative costs: With simpler tax procedures, you might be able to handle your tax preparation or have lower accounting fees compared to more complex business structures.
• Direct control over profits: As a sole proprietor, you retain all the profits from your business. You don't have to split them with partners or shareholders.
• Easy to start: You don't need to go through a formal application process to establish a sole proprietorship. If you're the sole owner of a business and haven't registered as another entity type, the IRS automatically considers you a sole proprietor.
• Flexibility: Even if you form a single-member LLC, you still benefit from pass-through taxation by default. However, you have the flexibility to elect to be taxed as an S corporation or C corporation if it's more advantageous for your situation.

These tax benefits, combined with the ease of forming a sole proprietorship, make it an attractive option for many small business owners and entrepreneurs.

Sole proprietorship taxes for LLCs

While LLCs offer liability protection that sole proprietorships don't, their tax treatment can be surprisingly similar. This is because the IRS, by default, treats a single-member LLC as a "disregarded entity" for tax purposes. 

In other words, the business's profits and losses are "passed through" to the owner's personal income tax return, just like a sole proprietorship. You'll report this income and expenses on Schedule C of Form 1040.

This pass-through taxation simplifies tax filing significantly. You won't need to file a separate tax return for the LLC, and the process mirrors that of a sole proprietorship. You'll still be responsible for paying self-employment taxes on your LLC's profits, but LLCs offer more tax flexibility than sole proprietorships. 

While pass-through is the default, you can elect to have your LLC taxed differently. This choice can significantly impact your tax burden and overall financial strategy. 

Here are the main options:

• S Corporation: This can be beneficial if you want to take a salary and pay yourself dividends. This strategy can potentially reduce your self-employment tax burden, although the IRS will scrutinize your salary to ensure it's reasonable.
• C Corporation: This might work for high-growth businesses aiming to reinvest profits or seek external investment. However, it comes with the downside of double taxation—once at the corporate level and again on dividends.

Even if you stick with pass-through taxation, forming an LLC can still offer benefits. It's common for LLCs to obtain an employer identification number (EIN), especially if they hire employees or operate under a name different from the owner's. This adds a layer of separation between your personal and business finances, which can be helpful for organization and liability protection.

Sole proprietorship tax deductions

Running a business gives you access to various tax breaks, which are deductions that help lower the taxes you owe. Independent business owners should take advantage of all possible deductions.  

As a sole proprietor, you can deduct various expenses for launching and running your business. You can deduct expenses that are necessary from your income. Here are some of the most common tax deductions available to sole proprietors:

Business expenses

Sole proprietors can deduct various expenses, such as office supplies, advertising expenses, and legal fees. For example, a graphic designer can deduct the costs of software subscriptions and marketing expenses.

Mileage

Vehicles are a must-use self-employed tax deduction that allows you to expense miles you drive for work. You can use a mileage tracker to help with this.

QBI deduction

As a sole proprietor, you may also qualify for the 20% qualified business income (QBI) deduction. This tax deduction allows taxpayers to deduct up to 20% of their qualified business income from their taxable income. The amount of the QBI deduction is your qualified business income times 20%. 

Home office expenses

If you have a space in your home that you use just for your business, you may be able to deduct expenses for your home office. The home office deduction can include a portion of rent or mortgage interest, utilities, and even depreciation.

Self-employment taxes

You’ll need to pay quarterly self-employment taxes. This is the employer and employee portions of Social Security and Medicare taxes. However, you can deduct the employer portion from your tax liability. 

Health insurance premiums

Sole proprietors who pay for their health insurance premiums may be eligible for a deduction. Deducting health insurance for self-employed individuals includes premiums for medical and dental. Keep in mind that there are certain criteria to qualify for this deduction.

Retirement contributions

As a sole proprietor, you have several options for saving for retirement and reducing your tax burden. Here are a few to consider:

• SEP IRA: A simple plan with high contribution limits (25% of net earnings up to $71,000) and tax-deductible contributions. It's easy to set up but offers less flexibility and might not be suitable if you plan to hire employees.
• SIMPLE IRA: Allows both employee and employer contributions, with a limit of $16,500 (plus catch-up) for 2025. It's easy to administer but has lower limits than a SEP IRA and may require matching contributions if you have employees.
• Solo 401(k): Specifically for those with no employees, this plan has a high combined contribution limit ($70,000 for 2025) and offers flexibility with Roth and traditional contributions. However, it can be more complex to manage.
• Other qualified plans: You can explore other options like defined benefit plans, but be aware they often have higher administrative costs.

How to file taxes as a sole proprietorship

Filing taxes as a sole proprietor or solopreneur involves several steps. Before beginning, gather items from your tax prep checklist. Here is a step-by-step process to help you navigate through this process:

• Gather necessary documents: Collect all financial records for your business, including expense receipts and bank statements. 
• Calculate your income and expenses: Determine your total business income and deductible business expenses. Keep records of your business-related transactions throughout the year. 
• Complete sole proprietor tax forms: Use the information to complete the appropriate tax forms. Report your business income and deductions on your personal return and calculate your self-employment tax on Schedule SE. 
• Maintain accurate financial statements: Keep detailed records and separate business and personal expenses. Accurate financial statements facilitate tax filing and help you understand your business's financial health. 
• File and pay taxes: Once all forms are ready, file your tax return by the deadline. You’ll likely be making estimated tax payments quarterly, but make sure to pay any remaining tax liability.

Note that if you paid independent contractors or freelancers over $600 during the year, you must send them a Form 1099-NEC before Jan 31.

Sole proprietorship tax mistakes to avoid

Even though sole proprietorship taxes are generally simpler than those for other business structures, it's still easy to make mistakes. These mistakes can lead to penalties, audits, or missed deductions. 

Here are some common ones to watch out for:

• Incorrectly reporting cash transactions: It's crucial to accurately track and report all income, even if you received it in cash. Failing to report cash income is a common mistake that can cause problems with the IRS.
• Misclassifying workers: If you hire help, correctly classify them as either employees or independent contractors. Misclassifying workers can lead to significant tax issues and penalties.
• Overlooking deductions: Many sole proprietors miss out on valuable deductions because they don't keep good records or don’t know all the eligible expenses. Keep detailed records of all your business expenses and stay informed about potential deductions.
• Missing estimated tax payments: If you're required to make estimated tax payments, failing to do so or paying late can result in penalties.
• Mixing personal and business expenses: Keep your personal and business finances separate. This makes it easier to track expenses, identify deductions, and avoid commingling funds, which can create legal and tax issues.
• Not keeping good records: Maintaining organized and accurate records is crucial for tax purposes. This includes receipts, invoices, bank statements, and mileage logs. Good recordkeeping makes tax preparation easier and helps you support your deductions during an audit.

To minimize errors, consider using accounting software, keeping detailed records, and consulting with a tax professional if you have complex tax situations.

Find peace of mind come tax time

Even if you plan to outgrow your sole proprietorship or hope to remain a solopreneur for a while, adhering to the IRS’ rules and guidelines is key. You’ll want to report all income to your state and the IRS. 

QuickBooks Self-Employed provides freelancers with essential tools to manage their business finances, track mileage, and categorize expenses—all in one place. This simplifies tax preparation and helps maximize deductions, making tax time less stressful and more efficient.

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