How Taxes Work for Sole Proprietors: A Complete Guide for Beginners
If you’re a freelancer, a consultant, or running a small business all by yourself, you’re likely a sole proprietor. It’s a simple business structure but the way sole proprietorship taxes work can be confusing at first.
Don’t worry, this guide breaks down everything you need to know in plain and simple terms (that won’t further confuse you).
We will walk you through how sole proprietors are taxed, how to file correctly, and what to watch out for. If you read this blog till the end, you will know what’s required, what’s optional, and how to stay compliant without losing your sleep.
What is Sole Proprietorship?
A sole proprietorship is the simplest type of business structure. So, let’s say you have started a business and haven’t yet registered it as an LLC or a corporation, then by default you are a sole proprietor.
There’s no legal separation between you and your business. This means that all income and expenses of the business will pass through to your personal tax return. This setup keeps things straightforward but also means that you will be eventually responsible for everything, including taxes applicable on your business.
How Are Sole Proprietors Taxed?
Let’s make this simple, sole proprietorship taxes are not paid separately like corporate taxes.
Instead, you report your business income and expenses on a form called Schedule C, which is submitted along with your personal Form 1040.
You will only pay tax on your net profit, not your gross income. So, if you made $80,000 in income and had $20,000 in expenses, you will be taxed on the $60,000 profit. This means that a higher profit of your business can push you into a higher tax bracket.
Now here’s another catch: sole proprietors pay both income tax and self-employment tax.
- Income Tax: This depends on your total income and filing status.
- Self-Employment Tax: This covers Social Security and Medicare. For 2025, this is 15.3% on net earnings.
Sole Proprietorship Tax Filing, What Forms Do You Need?
When it comes to sole proprietorship tax filing, here are the key forms you need to know about:
- Form 1040: Your personal income tax return.
- Schedule C (Form 1040): Where you report income and expenses of your business.
- Schedule SE: This calculates your self-employment tax.
Depending on your situation, you may also need to file:
- Form 8829: If you’re claiming a home office deduction, you have to fill in this form.
- Form 4562: This form is filed with the tax return if you want to file for depreciation on large business assets.
Do Sole Proprietors Pay Estimated Taxes?
Yes, and this is a major area that trips people up. The IRS expects sole proprietors to pay taxes throughout the year and not just at the tax time. These are called estimated quarterly taxes.
You will need to make estimated tax payments if you expect to owe $1,000 or more in taxes after deducting withholding and refundable credits at year end.
The deadlines for quarterly payments are:
- April 15
- June 15
- September 15
- January 15 of the following year
Missing these deadlines can lead to penalties, even if you pay your full tax bill later.
What Can You Deduct
You don’t want to pay tax on income you didn’t actually get to keep, right? That’s where business deductions come in.
As a sole proprietor, you can deduct legitimate business expenses to reduce your taxable income. Here are some common ones:
- Office supplies
- Business mileage
- Internet and phone bills (business portion)
- Software subscriptions
- Marketing and advertising
- Professional services like legal or accounting
- Home office (if it qualifies)
Keep good records of all your expenses, receipts, invoices, and bank statements. This not only helps with deductions but is also important if you’re ever audited.
Sole Proprietorship Taxes and Retirement Contributions
Here’s some good news, contributing to retirement plans not only helps your future but it can also lower your tax bill.
Sole proprietors have a few retirement options:
- SEP IRA
- Solo 401(k)
- Simple IRA
These plans allow you to set aside money for retirement while reducing your taxable income. A win-win.
Common Mistakes in Sole Proprietorship Tax Filing
Tax time can be stressful, especially if you’re handling everything yourself. Here are a few things to avoid:
- Mixing Personal and Business Expenses: This is a common mistake and a highly discouraged one by experts. Always keep a separate business and personal bank account.
- Not Tracking Income Accurately: One mistake sole proprietors often make that causes them tax stress is not getting invoices issued and storing them.
- Forgetting to Pay Quarterly Taxes: As we mentioned earlier, not paying quarterly taxes can lead to penalties. So, ensure timely payment by setting reminders or automating the process.
- Claiming Incorrect Deductions: This is a common one. Best is to consult a tax expert to help you know what’s allowed and what’s not.
A little organization throughout the year can save you a major headache later.
Need Help with Sole Proprietorship Tax Filing?
Understanding how sole proprietorship taxes work gives you more control over your business and financial future. While taxes can feel overwhelming at first, you don’t need to panic.
Start by knowing what’s required, track everything, make estimated payments, and don’t be afraid to ask for help. The more proactive you’re the better each tax season will be.
And if you’d rather focus on growing your business instead of crunching numbers and tackling tax forms, let the professionals step in. We recommend you Monily by Arthur Lawrence for expert help with sole proprietorship taxes, bookkeeping, and accounting. The expert team at Monily makes it super easy to stay compliant and make better financial decisions for your business.
Let the folks at Monily handle the numbers for you and you can handle the business. Head over to Monily today and learn about how their team can help improve your sole proprietorship tax filing process.
Remember, taxes aren’t just something you deal with once a year. Make taxes a part of your overall business strategy and see the impact yourself.