Sole Proprietors and Taxes

Deciding to open a new business is a brave choice. Being solely responsible for a company and its employees can be daunting. Every business decision you make can impact your bottom line. However, if you align yourself with the right people, being a small business owner offers lifelong rewards.

Of course, the risks and rewards of running your company depend on your business structure. One of the riskiest options is to become a sole proprietor. Not only are you responsible for the day-to-day operations of your company, but you’re also responsible for your business taxes.

Knowing what to do, how, and when to do it can be overwhelming for a small business owner. Employing an experienced tax lawyer to help with your small business taxes is a good idea. Becoming familiar with the tax laws and IRS rules can take years.

Here, we’ll explain how sole proprietors should handle their tax returns and business tax liabilities. Contact a local tax professional or a tax attorney if you have questions about your business income or self-employment taxes.

How Are Sole Proprietorship Taxes Different from Other Business Entities?

One of the primary differences between sole proprietors and other small business owners is how they pay their taxes. Most business owners file their individual tax returns separately from their business tax returns. However, as a sole proprietor, you only file one IRS tax return.

When you are a sole proprietor, your personal and business income are the same for tax purposes. The IRS considers your business a pass-through entity. This means that your business income passes through to your personal income.

So, the IRS doesn’t tax your business when you’re a sole proprietor. Your business does not file separate taxes. Instead, you’ll report your income and losses on your federal income tax return.

Sole Proprietorship and Pass-Through Taxation

With pass-through taxation, you’re personally responsible for paying taxes on your business profits. When you file your federal tax return, you must include all income from your sole proprietorship and other sources.

One of the downsides of pass-through taxation is that your net profits can put you in a different tax bracket. This means you’ll pay a higher income tax rate than if you filed your personal income tax return separately.

Pass-through taxation applies to a limited liability company (LLC) as well. If you have a single-member LLC, you must include your business revenue on your personal income tax returns. At the same time, this type of taxation also allows you to claim certain losses that you otherwise would not be able to deduct, such as health insurance premiums.

How to File Taxes as a Sole Proprietor

Individual taxpayers typically file an IRS Form 1040 or Form 1040 ES. As a sole proprietor, you must attach another form, “Schedule C,” to your personal tax return. This schedule lists your business profits, losses, and expenses.

The IRS allows you to deduct your everyday business expenses on this form.

However, you are not allowed to deduct the following:

• Owner’s draws, distributions, and paychecks
• Cash infusions from loans and investments
• Payments on any long-term debt

Other deductions are also limited, such as a 50% limit on business meals and travel. You can also claim a home office deduction, but only insofar as the space is used exclusively for business purposes.

In addition to your 1040 and Schedule C, you must also file Form Schedule SE. The IRS requires that you file this form to pay your quarterly self-employment taxes.

As you can see, dealing with taxes as a business owner can be challenging. This is why most business owners rely on certified public accountants (CPA) or other tax professional during tax time. You may even want to meet with a local tax lawyer to ensure you follow the IRS rules and requirements.

Tax Deductions and Business Expenses

As a small business owner, you must understand what you can and cannot deduct on your income tax return. We mentioned a few of these briefly above. However, it’s worth delving a bit deeper into this topic. You don’t want to invite an IRS audit by claiming deductions that sole proprietors are not entitled to.

As a sole proprietor, you can deduct the following:

• Payroll taxes
• Medicare taxes
• Social Security taxes
• Sales tax
• Health insurance premiums
• Business mileage
• Home office
• Self-employment taxes
• State taxes

Every business has a unique set of expenses. Consult a licensed tax professional before you submit your tax returns.

Determining Your Tax Obligation as a Small Business Owner

Once you complete your federal tax return, you must pay taxes on your qualified business income and other personal income. Most business owners include their estimated tax payments when they submit their tax returns.

If you don’t pay your taxes on time, the IRS will charge you penalties and interest. You may also trigger an IRS audit if you don’t send your tax payment in with your return. There is a chance the IRS will come back and say you owe more than the estimated amount. If that’s the case, you must remit the additional tax payment right away.

A Skilled Tax Attorney Can Help

When you’re a sole proprietor, you must file your business taxes properly. Even if your business is small, you should employ a bookkeeper or someone to handle your accounts payable and accounts receivable.

In addition to having someone on staff to handle your tax issues, you should consult a tax expert to help file your taxes. If you face any legal problems with the IRS, meet with a tax attorney to help achieve the best possible outcome.