A sole proprietorship is a relatively simple business structure, and in fact, the most simple, according to general consensus. Under tax law, a sole proprietorship is the same as its owner; they share no legal differences, and the business owner is personally obligated to pay the debts of the business. A sole proprietor files only a few forms to show income, losses and expenses. However, just because this type of business is the simplest of them all does not mean that everything tax-related is simple. Read on to find out what you need to know about sole proprietorship taxes.
A Few Basics
Regular employees—people who are not sole proprietors—generally do not have to worry about figuring out their tax payments during the year. Their employers take care of withholding taxes for purposes such as Social Security. However, sole proprietors are their own bosses and must make tax payments during the year. That is, they must pay taxes to the Internal Revenue Service if they predict they will owe a minimum of $1,000 for the entire year. As a sole proprietor, you typically pay estimated taxes in four quarterly payments in April, June, September and January. You can make your estimated payments online or mail them through postal mail. When it comes time to file your yearly return, you can do so through many, if not most, of the sites that help regular employees file their returns.
Making Accurate Estimates
Try to be as accurate as possible when you estimate how much you will owe in taxes. If you underestimate to the point where you have paid less than 90 percent of your tax liability, you might get penalized. When estimating, include such factors as business expenses and other income such as dividends that you may have. Form 1040-ES on the IRS website has a worksheet to help you figure out estimated taxes.
Required Forms and Keeping Records
To file sole proprietorship taxes, you need a few forms:
- Personal income return
- Schedule C or C-EZ (to show your expenses, profits or losses) OR Schedule F (if your business is a farm business)
- Schedule SE (for self-employment tax)
The IRS website gives an in-depth look at the forms that sole proprietors need, and you should take any business deduction you are legally entitled to. Common deductions include advertising expenses and equipment costs (computers, for example). It is vitally important that you keep detailed records because, unfortunately, some sole proprietors abuse the system. They claim expenses that are not really business related. If you are audited, you want to be able to back up every deduction you take. Accountants advise sole proprietors to maintain business records and personal records separately so that there is no question about which category an expense falls into.
Changing Your Business Structure
A sole proprietorship might want to incorporate for the lower tax rates, but doing so can be a pain. On the other hand, a corporation is legally distinct from its owner, and corporate owners often bypass paying taxes on the earnings of the business. The corporation, separately from the owner, is the one that pays tax on business profits. There is no doubt, though, that incorporating and paying taxes is definitely more complex than filing taxes as a sole proprietorship. You need to decide for yourself which is more important, saving potentially a few thousand dollars or avoiding the significant potential issues that come with incorporation.Many business owners, whether they participate in sole proprietorships, partnerships, limited liability companies or corporations, seek the advice of attorneys and accountants when it comes to taxes and following the law. While an accountant costs money, that person can help a sole proprietor ensure the law is being followed and can be particularly useful in the first year or two of a business.
The content on our website is only meant to provide general information and is not legal advice. We make our best efforts to make sure the information is accurate, but we cannot guarantee it. Do not rely on the content as legal advice. For assistance with legal problems or for a legal inquiry please contact you attorney.