How Are Sole Proprietors Taxed?
As far as the Internal Revenue Service is concerned, you are a sole proprietor if you earn a business income, do not have a business partner and you are not registered as a corporation or as a limited liability company. As a sole proprietor, there is no distinction between your personal income taxes and your business income taxes, but you do face special issues when it comes to filing your taxes, making tax payments and deducting your expenses.
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Business Deductions
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As a sole proprietor, you are allowed to deduct your business-related expenses. Tax deductions reduce your taxable income, which is the amount used to determine the tax you have to pay. For example, if you sell a product, you can deduct the cost of buying or producing the product you sell. In addition, you can deduct related costs, such as marketing expenses, employee salaries you paid, office expenses and other expenses directly related to your business.
Estimated Tax Payments
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When you are an employee, your company is required to withhold taxes from each of your your paychecks. As a sole proprietor, it is up to you to pay the government what you owe. When you are self-employed, you have to pay an estimated tax four times per year, filing an IRS 1040 ES form quarterly. Filling out this form will help you determine how much money you need to pay each quarter you file it.
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Self-Employment Tax
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When you work for another company, the company pays part of your Social Security and Medicare taxes for you and they withhold the portion you are required to pay from your paycheck. When you are self-employed, you are required to make the entire payment for these taxes yourself in the form of a self-employment tax. At the time of publication, the self-employment tax is 13.3 percent of your self-employment income, according to the IRS.
Filing Schedule C Versus Schedule C-EZ
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As a sole proprietor, you are required to file an additional Schedule C form with your IRS 1040 tax return. Schedule C is the form you use to deduct your business expenses. Like the 1040 form, there is a long Schedule C form and a short form called Schedule C-EZ. You can use the EZ form, which is simpler to fill out, as long as your expense deductions are less than $5,000, you use the simple cash accounting method to calculate your deductions, you do not have a business inventory and you are not claiming a net business loss on your tax returns. In addition, you must use the long form if you have employees, if you use depreciation and amortization methods to reduce your taxable income, if you plan to deduct home use as a business expense and finally, you do not have any carry-over losses from previous years that you wish to use as deductions during the current tax year.
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