A sole proprietorship is the simplest way to set up a business. In California, you are your sole proprietorship. Its profits are your profits, its losses are your losses and its liabilities are your liabilities. Although this tight integration between you and your business can carry a number of risks, it also simplifies the way the state taxes you.
California Taxation of Sole Proprietorships
California's tax treatment of a sole proprietorship is in line with the federal standard. This means that sole proprietors will need to file a federal Schedule C and enclose a copy of it with their Form 540 California tax return. Their Schedule C income is treated as regular income for California state income tax purposes. With this in mind, it is subject to the same marginal tax rates as any other income. Tax brackets vary depending on the taxpayer's filing status and are calculated based on the total of all of the taxpayer's income, whether it comes from a sole proprietorship, a job or some other income source.
Single Sole Proprietors and Married Sole Proprietors Filing Separately
For this filing status, the first $7,124 in taxable income is taxed at a 1.25 percent rate, which increases to 2.25 percent for income between $7,125 and $16,890. Income between $16,891 and 26,657 is taxed at 4.25 percent while income from $26,658 and $37,005 is subject to 6.25 percent tax. The 8.25 percent tax applies to income over $37,006 and up to $46,766, and California's 9.55 percent rate applies to all income over $46,767. These brackets were in effect for the 2010 tax year, as were all other brackets discussed in this article.
Married Sole Proprietors Filing Jointly
California has no marriage penalty in its tax rates and brackets. What this means is that the tax brackets for a married couple filing together are twice those for single people, so that a married couple should pay the same tax that they would pay if they were filing separate returns as single people. For example, the threshold at which income is taxed at 4.25 percent comes at $33,781, which is twice the single threshold of $16,891.
Head-of-Household Sole Proprietors
Sole proprietors who file as heads of household enjoy tax brackets which fall between singles and married couples. Their first $14,257 of income is taxed at 1.25 percent, while income between $14,258 and $33,780 is subject to 2.25 percent tax. These brackets are similar to those for married couples filing jointly, but higher brackets diverge. Heads of household pay 4.25 percent tax on income between $33,781 and $43,545, 6.25 percent on income between $43,546 and $53,893 and 8.25 percent on income between $53,894 and $63,547. The highest rate of 9.55 percent applies to marginal income above $63,658.