When and how do I file and pay taxes as a sole proprietor?
Most sole proprietors need to file income tax returns and pay taxes on their business income. Under IRS rules, you must file an income tax return if your net earnings from your business totaled $400 or more. Note that even if your self-employment earnings were less than $400, you might still have a tax filing obligation, or be eligible for a refund. And, as is the case with other types of business entities, sole proprietors are also subject to self-employment taxes.
As a sole proprietor, instead of filing a separate tax return for your business, you report your business income on IRS Form 1040, using Schedule C to report your business profit or loss. According to the IRS, Schedule C is required when the primary purpose of your business is for income or profit and you are regularly involved in the activity. Be prepared to use Schedule C to report your accounting method, gross receipts, sales, income, cost of goods sold, and deductible business expenses. If you have more than one business as a sole proprietor (for example, you have two separate side businesses), you will need to complete a separate Schedule C for each business.
Depending on the nature of your business, you may need to file additional tax schedules with your return. You can gain valuable peace of mind when you have a tax pro file for you, rather than trying to determine which schedules are required, calculating your tax obligations, completing forms and schedules, and filing your own tax returns.
Can I write off expenses as a sole proprietor?
Yes, as a sole proprietor, you can write off certain business-related expenses. Doing so potentially lowers the amount you will ultimately owe in taxes. To be deductible under IRS rules, an expense must be considered both ordinary and necessary. An expense is ordinary when it is a common one for your industry. A necessary expense is something that is both helpful and appropriate for your sole proprietorship.
Some of the most popular sole proprietorship tax deductions include the following:
- One-half of the self-employment taxes paid (the employer portion).
- Sales taxes.
- Business licenses.
- Health insurance premiums (unless you are eligible to participate in an employer-sponsored plan).
- Business use of a vehicle (talk to your tax professional to determine which of the available methods for calculating your deduction will be most favorable for you).
- Home office deduction if you use part of your home regularly and exclusively for your sole proprietor business and it is your principal place of business.
- Qualified business income tax deduction of 20%, if your business qualifies.
- Internet and phone expenses (the portion attributable to your business).
- Business-related meals and entertainment.
- Qualified business travel expenses.
- Interest on business loans.
- Subscription costs for specialized publications.
- Education costs, when the course or training is related to your sole proprietorship.
- Business insurance expenses.
- Rent for office, warehouse, or retail space for your business.
- Certain startup expenses.
- Advertising and marketing costs.
- Self-employed retirement plan contributions.
The deductions listed above are the most common types of business-related expenses claimed by sole proprietors, but there are others. A tax attorney or other tax professional can help you evaluate which deductions your sole proprietorship may be able to take to lower your tax obligation.
What are the tax advantages of a sole proprietorship?
There are several reasons entrepreneurs choose sole proprietorships over other types of business entities. From a tax standpoint, one of the biggest benefits is streamlined filing when compared to corporate business entities.
First, whereas corporations, LLCs, and partnerships need their own tax ID numbers (also referred to as an Employer Identification Number, or EIN), sole proprietorships can opt to use the sole proprietor's Social Security Number for tax purposes. A sole proprietorship’s income and expenses are reported on the individual’s tax return, meaning that there is no need to file a separate tax return for the business entity if you are a sole proprietor. So, while the federal tax rate for corporate income is 21% for 2023, the sole proprietorship tax rate is effectively your own individual income tax rate, which may be lower. Some sole proprietorships may also qualify for a 20% deduction from the net business income, as provided under the Tax Cuts and Jobs Act of 2017.
Figuring out business taxes, tax rates, deductions, and credits can be complex. To claim deductions, credits, or most tax relief or incentives, you typically are required to qualify for and request these. Your tax professional can help you claim the tax write-offs that are available to your business.
Can sole proprietors get tax refunds?
Regardless of whether your business is structured as a sole proprietorship, corporation, or other type of entity, you are entitled to a tax refund if you pay more during the tax year than you actually owe. Your estimated quarterly tax payments are based on your income in the previous tax year. So, if you overpaid throughout the year in your estimated tax payments, you can claim a refund when filing your tax return.
Many sole proprietors also have "day jobs," with W-2 income and tax withholding. If the total amount you pay during the year through tax withholding and your quarterly estimated tax filings for your business are less than the amount due, you will owe taxes when you file your return (including possible penalties for underpayment). But, if your tax withholding from your W-2 job plus your estimated tax payments were more than the amount you owed, you may qualify for a tax refund.
What are my options if I am not able to file my taxes on time?
Filing tax returns on time, and paying what you owe in full by the payment deadline, is important. If you file your tax return after the deadline, you may be subject to hefty fees, penalties, and interest charges on unpaid taxes.
Sometimes, sole proprietors and other small business owners struggle to get their tax returns filed on time because it is a busy time of year for their business or there are issues with the documentation needed to prepare their returns. The IRS does offer an option to apply for an automatic extension of time to file tax returns by using Form 4868. This approach gives you an additional six months to file your return and tax schedules, effectively changing the filing deadline to October 15th. An extension of time to file your taxes, however, does not mean you have an automatic extension of time to pay your taxes. If you request an extension, you may want to estimate the amount of taxes you owe and pay what you can by the original deadline (April 15, 2024, for the 2023 tax year). The penalties and interest continue to accrue until you have paid your taxes in full, so the sooner you can pay, the better.
The reality for most sole proprietors is that taxes for their business income are an unwelcome, but necessary part of doing business. Because of the potential for penalties and interest to accrue when mistakes are made with business taxes, there is little room for error.
If you still have questions about how to file taxes as a sole proprietor, reach out to a Rocket Lawyer network attorney for affordable legal advice. If you need tax help, get matched with a tax pro via Rocket Tax™ to save time and money filling your tax returns.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.
