Running your business as a sole proprietor can help you keep things simple. Even from a tax perspective, it can help you minimize paperwork and take advantage of pass-through taxation for a single layer of income tax.
Still, being a sole proprietor comes with its own tax considerations. Fortunately, this guide can help break down the important aspects of navigating taxes if you’ve chosen to run your business as a sole proprietorship.
Taxability: Sole proprietor and Limited Liability Company
A sole proprietor is how the IRS identifies an individual who engages in business without owning a legal entity. When an individual receives income outside of being an employee, that income is taxed at their individual tax rate. This is known as pass-through taxation and occurs in single-member limited liability companies and partnerships. Sole proprietors report their income and expenses on a form called Schedule C. Then this form is attached to their personal income tax return, Form 1040. A sole proprietor is obligated to report all income they earn. If a sole proprietor will owe over $1,000 in taxes to the IRS, they should plan to pay quarterly estimated taxes.
An owner of a single member limited liability is taxed the same way and uses the same forms as a sole proprietor.
Sole proprietorships are the easiest business entity structures to self-manage when you have a relatively low income. You also don’t have to formally establish a business entity.
Required tax payments
Sole proprietors must pay more taxes than they would if they were just regular W-2 employees. Once you start engaging in business, you become liable for federal and state taxes. Your business taxes depend on your business industry, location, business operations, employees, and other variables. ComplYant assists small business owners in managing these taxes by providing users with a Tax Calendar that encompasses all their tax due dates, forms, and payment options.
Unlike legal entities, sole proprietors are not responsible for paying unemployment taxes.
There are some federal tax forms you should know.
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Estimated Income Tax | Estimated Income Tax | ||||||||
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Federal tax forms you should know
Federal income tax
Schedule C (Form 1040 or 1040-SR), Profit or Loss from Business
Unlike a W-2, you will report your income and expenses on Schedule C. Schedule C is a replication of your profit and loss statement of your business, so it would be handy to have your company’s profit and loss statement on hand.
Self-employment tax
Schedule SE (Form 1040 or 1040-SR), Self-Employment Tax
Sole proprietors pay self-employment tax at a rate of 15.3%. Typically, an employer would be responsible for 7.65% of this amount, and the remaining 7.65%, (known as FICA) is the responsibility of the employee. Since a sole proprietor is responsible for the entire amount, they can deduct 50% of the total amount you paid on Schedule C.
Other information returns
As a sole proprietor, you should provide a W-9 to the business that provides you payment for your services. The company will use the information on your W-9 to provide you with a 1099-NEC, which you will use to report your other income on Schedule C.
Non-employee compensation is reported to the IRS on Form 1099-NEC. A sole proprietor should receive a 1099-NEC from a business that earned $600 or more in income during the tax year. Sole proprietors need to report the information from their 1099-NEC to their Schedule C exactly as shown on Form 1099. The IRS will receive a copy of your 1099-NEC and compare the information you reported to the information on the 1099-NEC they received.
You should receive this form by January 31st. If you have not, you should reach out to each business you provided services of $600 or more and request form 1099-NEC.
Ro's Tax Tip: If you do not owe any taxes, you should still file that shows zero income made. This is called zeroing out a return.
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