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.
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.
One of the key aspects of sole proprietorship taxes is self-employment tax. This tax supports Social Security and Medicare. As a sole proprietor, you must pay the full self-employment tax rate of 15.3%. When you work for an employer, you only pay half, and the employer pays half. But as a sole proprietor, you can claim 50% of your self-employment tax payment as a deduction for income taxes.
To meet your tax obligations as a sole proprietor, you may need to pay quarterly estimated tax payments throughout the year. Form 1040-ES can help you calculate your estimated tax payments.
One of the key sole proprietorship tax benefits is the simplicity of the tax treatment. The business structure allows for pass-through taxation, which means you can file it on your personal tax return.
You don’t need to apply to form a sole proprietorship. If your business has a single owner, the IRS will consider you a sole proprietor by default. For example, self-employed individuals are sole proprietors until they form a business entity.
Note that even if you form a single-member LLC, the tax status defaults to pass-through, but you can file an election with the IRS to change the status.
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:
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.
Vehicles are a must-use self-employed tax deduction that allows you to expense miles you drive for work. If you use your car for business, you can deduct 65.5 cents per mile for 2023. You’ll want to keep good records to keep your personal and business miles separate. You can use a mileage tracker to help with this.
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%.
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.
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.
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.
Sole proprietors can contribute to retirement plans. There are various 401(k) plans, but the solo 401(k) is particularly great for sole proprietors. There are also other options like individual retirement accounts (IRAs). These retirement plans help you save for the future and provide tax advantages.
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:
Note that if you paid independent contractors or freelancers over $600 during the year, you must send them a Form 1099-NEC before Jan 1.
We can help you with extension filing before tax deadlines to avoid penalties.
Learn how.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.
Having a business bank account like QuickBooks Money that allows you to make payments and send payable invoices instantly, with no monthly fees, can help keep your personal and business expenses separate—making tax time easier and more efficient.
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