How a Sole Proprietor Pays Income Tax - And Other Taxes

Sole Proprietor Income Taxes, Self-employment Tax, Estimated Tax and More

A business owner in her shop
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sole proprietorship is a business operated by an individual owner. The sole proprietor is unique for several reasons:

  • It's the default business type. If you want to start a business, you can just get started and you're automatically a sole proprietor for tax purposes.
  • A sole proprietorship doesn't have to register with their state.
  • There's no separation between the owner and the business in a sole proprietorship for both tax and legal purposes. As we'll see, that can be a good and not-so-good thing.

What Makes Sole Proprietors Different

Sole proprietors are solo owners of unregistered businesses. That means they don't register the business with a state. For legal and tax purposes, sole proprietors are the only business type that isn't separate from the owner. The owner is liable for all the debts of the business and can be sued for actions of the business.

For tax purposes, a sole proprietorship is considered a "pass-through" business. The profits or losses of the business pass through to the owner's personal tax return.

You're a single-member LLC and you pay income taxes in the same way as a sole proprietor, including self-employment taxes, if you're the only owner of a limited liability company (LLC). This information applies to you, too. 

How Sole Proprietors Pay Income Tax

A sole proprietorship is taxed through the personal tax return of the owner, on Form 1040. The business profit is calculated and presented on Schedule C, Profit or Loss from Small Business. To complete Schedule C, the income of the business is calculated including all income and expenses, along with cost of goods sold for products sold and costs for a home-based business. The result of this calculation (income minus expenses) is the net income (the amount of taxable business income).

This net income or loss of the business is entered on Line 31 of the owner's Schedule C, to be included along with other income/losses of the owner (and spouse) for income tax purposes. The figure is entered on Line 3 of the Form 1040 if the business has a profit. A loss may be used to reduce the total adjusted gross income of the owner (the income before exemptions and deductions) on the tax return if the business has a loss.

The owner of the sole proprietorship pays income tax on all income listed on the personal tax return, including income from business activities, at the applicable individual tax rate for that year.

Self-Employment Tax

A sole proprietor is a self-employed individual and must pay self-employment taxes (Social Security/Medicare tax) based on the income of the business. Self-employment tax is included in Form 1040 for federal taxes, calculated using Schedule SE. If the business has a loss, no self-employment tax is payable, but the owner doesn't receive Social Security/Medicare benefit credits for that year.

Here is an example (greatly simplified):

Terry is a sole proprietor, a single tax filer.

  • They completes their Schedule C, which shows their net business income as $10,000. This is their taxable business income.
  • They must pay self-employment tax of 15.3% on this income, or $1,530. They get a deduction of half this amount, so they must pay $765 toward this tax.
  • They also have an income of $12,000 for a part-time job.
  • The Schedule C income of $10,000, the self-employment tax of $765, and their taxable work pay are all used as part of the calculation of the income tax they owe for the year.

Estimated Taxes

Because a sole proprietor is not an employee, no income taxes or self-employment taxes are withheld from their pay. The IRS requires that these taxes be paid throughout the year, not just at tax time. That means you must make estimated tax payments each quarter (April 15, June 15, September 15, and October 15 of the next year).

The IRS has extended the April 15, 2021 estimated tax payment deadline to June 15, 2021 for taxpayers in Texas in response to the 2021 winter storms. The IRS announced on Feb. 25, 2021 that this relief will extend to taxpayers in Oklahoma as well.

This article has tips for ways to calculate your estimated tax payments, using the best guess of your business income for the year. Don't forget to include an estimate of self-employment tax due on that income!

Other Employment Taxes

If a sole proprietor has employees, the business must pay employment taxes on their incomes, including withholding and reporting federal and state income taxes, paying and reporting FICA (Social Security and Medicare) taxes, workers compensation taxes, and unemployment taxes. They're deductible business expenses if your sole proprietor business pays employment taxes. Of course, amounts withheld from employees and forwarded to the government by your business are not deductible to your business. 

Property Taxes

If the sole proprietor owns a building or other real property (land and buildings), property taxes are required to be paid on this property. The tax is based on appraised value and tax rates for the town or city where the business is located.

State Sales, Excise, and Franchise Taxes

Sole proprietors are required to pay state sales taxes on products and taxable services sold by the business. In addition, the sole proprietor may have to pay excise (use) taxes in the same manner as other business types. 

Check with your state department of revenue for more information on sales and excise taxes. Sole proprietorships are not typically liable for franchise taxes because these are levied by states on corporations and other types of state-registered businesses.

Deducting Business Tax Payments

Taxes your business pays might be deductible as business expenses, but you can't deduct federal income taxes.