A Guide to Sole Proprietorship Taxes – Forbes Advisor

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Sole proprietorships – run by freelancers, consultants or other independent contractors – generally have simple taxes compared to other business structures. However, there are specific tax guidelines sole proprietors should follow come tax season.

Let us walk you through Sole Proprietorship Taxes to make sure you don’t make any mistakes when paying Uncle Sam.

What is a Sole Proprietorship?

A sole proprietorship is owned by one person and the owner does not have a separate legal existence from the business. As the sole proprietor, you are entitled to all income; however, you are also personally liable for any debts and losses incurred.

Similar to partnerships and S corporations, a sole proprietorship is considered a flow-through entity, which means that profits and losses are reported on the owner’s personal income tax return instead of being subject to tax. on companies.

The sole proprietorship has several advantages and disadvantages, including the following:

Advantages of a Sole Proprietorship

  • Easy to train. A sole proprietor is simple and easy to train. It is the cheapest of all business structures and does not require complicated paperwork.
  • Full ownership. Unlike other business entities, you have full control of your business, your decisions, and all profits earned by your sole proprietorship.
  • Simplified tax declaration. Sole proprietors can report their business income and deductions on their personal income tax return.

Disadvantages of a Sole Proprietorship

  • Unincorporated and unlimited liability. Sole proprietorships are generally unincorporated entities, which means that they are personally liable for all business debts and other obligations.
  • Limited funding. It can be difficult for a sole proprietor to obtain financing. Unlike corporations, sole proprietorships cannot raise funds through the sale of stock, and some banks may only provide limited funding.
  • 100% responsible for losses and debts. While full ownership of a sole proprietorship is an advantage, it also has the disadvantage of being fully liable for losses and debts incurred by your business.

How to pay sole proprietorship taxes

Sole proprietorship taxes depend on your net profit (income minus expenses), whether you have employees, and whether you are subject to local and state taxes.

Self-employment taxes

You are required to pay self-employment taxes on your net profits, which occurs when your business income exceeds your expenses. The self-employment tax rate is 15.3% for 2022, which consists of two parts:

  • Social contribution : 12.4%
  • Health insurance tax: 2.9%

For 2022, the first $147,000 of your combined wages, tips, and net profits are subject to Social Security taxes, and all of your combined earnings are subject to Medicare taxes. Additionally, if your combined income exceeds $200,000 for 2022, you will pay an additional Medicare tax rate of 0.09%.

Generally, the amount of your net profit subject to self-employment tax is 92.35%. For example, if you made a net profit of $50,000 from your sole proprietorship, you would pay $7,065, or 15.3% of $46,175 ($50,000 x 92.35%).

There are also instances where you are not required to pay self-employment taxes, for example, if your net profits were less than $400 for the tax year.

Federal and state income taxes

In addition to self-employment taxes, you must pay taxes on your net profits. In some cases, this includes both federal and state taxes, depending on where you live.

The amount of federal income tax you owe depends on the federal tax bracket you fall into. There are seven federal tax brackets: 10%, 12%, 22%, 24%, 32%, 35% and 37%.

The state in which you reside or earn your income also determines whether you must pay income taxes. However, some states, including Washington, Florida, and Texas, do not impose income tax.

Employment taxes

In addition to self-employment, federal and state income taxes, if you hire employees for your business, you will pay labor taxes.

Generally, employers must retain and file for their employees:

  • Federal and state income taxes
  • Federal Insurance Contributions Act (FICA) taxes
  • Federal Unemployment Tax Act (FUTA) taxes for their employees

You should also note that as a sole proprietor, you cannot consider yourself an employee of your business.

Tax deductions for sole proprietors

Understanding your deductions is essential when you are a sole proprietor. Since you are only taxed on your net profits, it pays to take advantage of available tax deductions.

Common tax deductions for sole proprietors include:

  • Self-employment taxes
  • Healthcare insurance
  • Professional mileage
  • Business meals in the restaurant
  • Advertising costs
  • Rent and rental costs
  • Home office deduction
  • Cellphone

It’s always a good idea to speak with a tax professional about your sole proprietorship and the deductions available to you.

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