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 are required to 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. Additionally, as is the case with other types of business entities, sole proprietors are 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 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 operate more than one business as a sole proprietor (e.g., 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. If you’re unsure which forms or schedules are required, refer to the IRS Instructions for Schedule C for current filing details.
Can I write off expenses as a sole proprietor?
Yes, as a sole proprietor, you can write off certain business-related expenses, potentially lowering the amount you 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 common in your industry. A necessary expense is one 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.
- 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 deduction (if your business qualifies).
- Internet and phone expenses (the portion attributable to your business).
- Business-related meals (subject to certain limitations).
- Qualified business travel expenses.
- Interest on business loans.
- Subscription costs for specialized publications.
- Education costs related to your business.
- 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.
- Software expenses.
- Wages to employees and payments to independent contractors.
- Legal and professional services.
The deductions listed above are the most common types of business-related expenses claimed by sole proprietors, but there are others. Be sure to consult official IRS guidance on Business Expenses for current information on which deductions may apply to your business.
It is important to keep accurate records of your income and expenses in case your business is audited by the IRS. Digital records are generally sufficient for an IRS audit, and the IRS increasingly allows paperless responses to IRS correspondence.
What are the tax advantages of a sole proprietorship?
There are several reasons entrepreneurs may choose a sole proprietorship over other types of business entities. From a tax standpoint, one of the biggest benefits is streamlined filing compared to corporations and partnerships.
While corporations, LLCs, and partnerships need their own tax ID numbers (Employer Identification Numbers, or EINs), sole proprietorships can use the owner’s Social Security Number for tax purposes. A sole proprietorship’s income and expenses are reported on the individual’s tax return, eliminating the need to file a separate business tax return.
Additionally, some sole proprietorships may qualify for a deduction on net business income under the qualified business income deduction rules.
Can sole proprietors get tax refunds?
Regardless of your business structure, you are entitled to a tax refund if you pay more during the year than you owe. Your estimated quarterly tax payments are typically based on your income from the previous year. If you overpaid during 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 estimated payments is less than the amount due, you’ll owe taxes (including possible penalties for underpayment). However, if your total payments exceed the amount owed, you may qualify for a 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 deadline is important. If you file your return after the due date, you may be subject to penalties and interest charges on unpaid taxes.
Sometimes, sole proprietors struggle to file their returns on time because it’s a busy period for their business or they are waiting for important documents. The IRS allows you to request an automatic extension of time to file by using Form 4868, which grants an additional six months to submit your return and schedules.
However, an extension of time to file does not extend the time to pay your taxes. If you request an extension, estimate the amount you owe and pay what you can by the standard April filing deadline. Penalties and interest will accrue until your taxes are paid in full.
The reality for most sole proprietors is that taxes on 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 Legal Pro for affordable legal information.
Please note: This page offers general legal information, not but not legal advice tailored for your specific legal situation. Rocket Lawyer Incorporated isn't a law firm or a substitute for one. For further information on this topic, you can Ask a Legal Pro.
