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Sole Proprietorship Taxation: A Basic Guide on Solo Taxes

Being a sole proprietor means that you and your business are one -- from the IRS perspective. When using this type of business formation it is important to understand the tax implications and rules for sole proprietors.

Manny Davis
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Being a sole proprietor means that you and your business are one -- from the IRS perspective. This type of business is considered a pass-through entity (like S corps, LLCs & Partnerships), which means anything that your business earns flows through to your individual tax return. Being a sole proprietor is defined as when any individual operates a business that isn't set up as a formal entity. The main reason so many people choose the sole proprietorship option is because of the ease of using it. When using this type of business formation it is important to understand the tax implications and rules for sole proprietors.

Tax & Filing Obligation of a Sole Proprietor

  • Tax Return Filing: With a sole proprietorship there is no formal entity that exists other than the individual who runs the business. Since there is no other formal entity, all of the profits/losses from the operations of the business are reported on IRS Form 1040 (standard annual tax return). The main difference between how income is reported from a sole proprietorship versus how income is reported from job wages is that profits and losses from the proprietorship are listed on Schedule C of Form 1040. On Schedule C, the sole proprietor must report all income and business expenses and then come up with a total number for net profit or loss for the business.
  • Estimated Taxes: Since the majority of sole proprietors are not subject to tax withholdings they must pay estimated taxes. Estimated taxes are used to pay both income taxes and self-employment taxes. Typically, any sole proprietor who makes more than $1,000 after subtracting withholdings and other tax credits is required to make estimated tax payments. Do you have to make estimated tax payments? Use IRS Form 1040-ES to quantify and pay your estimated tax bill. Estimated tax payments are due quarterly, on April 15, June 15, September 15 and January 15 of the subsequent year.
  • Expenses: When taking business deductions, the rules are fairly similar for a sole proprietor and a large company that exists as a formal entity. Expenses that are considered "ordinary and necessary" in order for you to try to make profit through your business can be deducted. An ordinary expense is defined by the IRS as being common and accepted in your trade or business. A necessary expense is defined by the IRS as being helpful and appropriate for your trade or business.
  • Record Keeping: One of the biggest benefits to being a sole proprietor is the ease in keeping records. The IRS does not have a required methodology for businesses or individuals to organize and keep records, but it is important to keep records in an orderly fashion to report to the IRS and to defend yourself against any problems the IRS may have. One problem that many sole proprietors run into is mixing business and personal expenses, and thus it is important to have a method in place to keep these records separate. One common method to keeping records separate is to have a separate checking account and separate credit card that is used solely for business purposes.

While starting a sole proprietorship is the fastest and easiest way to get a business up and running, it is a good idea to take into consideration the implications of using each type of business entity and make an educated decision on which would suit your business needs the best. If need be, consider talking to a lawyer, financial adviser, and/or an accountant to help you make the best decision.

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