A sole proprietorship is the default IRS entity structure for freelancers and contractors who don’t form a corporation. It is also the default for single owners of limited liability companies (LLCs), but they can choose to be treated as a corporation if they prefer. Business income and expenses are reported on Schedule C of Form 1040. With this business structure, the company is owned solely by one individual—and there is no distinction for tax or legal purposes between the business and owner.
Key takeaways
- Sole proprietorships work best for business owners in industries with minimal liability and where the majority of income is generated by the efforts of the owner.
- Sole proprietorships are easy to set up and maintain.
- No formal registration results in reduced owner protection and more owner liability.
- Schedule C income is subject to income and self-employment tax and generally is taxed at the same rate as the business owner’s ordinary personal income.
- Sole proprietors should consider converting to an S Corporation (S-corp) if the cash they withdraw from the business is substantially less than the total business income.
Types of Sole Proprietorship Taxes
The two primary sole proprietorship taxes are income tax and self-employment taxes. However, sole proprietorships might also be required to pay payroll taxes and make estimated tax payments during the year.
Income taxes are paid by the sole proprietorship on their individual income tax return, Form 1040. Their business income is added to their income from other sources and tax is paid at their ordinary tax rate. So, part-time sole proprietors might face a very high tax rate on their sole proprietorship income if they have a full-time job that pushes them into a higher tax bracket.
Sole proprietors pay into the Social Security and Medicare system through self-employment tax. The business income is subject to a 15.3% self-employment tax, which is equal to the 7.65% of FICA generally paid by employers plus the 7.65% of FICA generally paid by employees. Essentially, sole proprietors must pay both sides of the FICA tax since they are both employer and employee.
In a sole proprietorship, the owner is not considered an employee. As such, the act of withdrawing cash from the business to pay the owner is not a wage payment and cannot be deducted for income taxes. The payment also has no effect on self-employment tax as it is assessed on business earnings regardless of the amount of cash withdrawn.
Sole proprietors with employees must follow the same rules as other employers. They must withhold income tax and the employee’s share of FICA taxes on all wages and salaries paid and must also file quarterly payroll tax returns and issue their employees a Form W-2 at the end of the year.
The amounts withheld plus the employer’s share of FICA taxes must be remitted to the IRS in regular intervals. While the payroll tax return, Form 941, is filed quarterly, more frequent payments are usually required. The interval may be quarterly, monthly, semiweekly, or daily, depending on the total payroll tax liability.
To determine your deposit schedule, you need to confirm how much you remitted in payroll taxes during the lookback period The lookback period extends from July 1 to June 30 of the prior year. For 2024, your lookback period would be July 1, 2022, through June 30, 2023. . Based on the lookback period, most employers use either a monthly or semiweekly schedule:
- Monthly: Reported tax liability of $50,000 or less during lookback period
- Semiweekly: Reported tax liability of more than $50,000 during lookback period
Two exceptions apply to the normal schedules.
- For any quarter in which the tax liability is less than $2,500 either in the current quarter or the prior quarter, the tax can be remitted with the quarterly payroll tax return.
- If a payroll tax liability of $100,000 or more is incurred in a single day, that amount must be deposited the next business day.
People you pay as contractors are not subject to payroll taxes, but you must report payments made to them on Form 1099-NEC if the payments total more than $600. Learn more about this gray area in our article on classifying employees vs independent contractors.
Most employers are subject to federal unemployment tax (FUTA). The government uses FUTA collections to manage unemployment insurance and subsidize workforce development programs. This tax is a 6% assessment on the first $7,000 of wages paid to each employee. This tax is only paid by employers. Nothing is withheld from employee paychecks for this tax, as employees do not have to pay it.
If a business owes more than $500 of FUTA tax in one quarter, that tax must be paid quarterly. The due date is the last day of the month following the end of the quarter Quarter 1 (January–March) FUTA taxes would be due April 30, Quarter 2 FUTA taxes (April–June) would be due July 31, and so on. . If you do not owe more than $500 of tax in one quarter, the FUTA tax owed is rolled to the next quarter until you reach the $500 threshold. Once you have reached $500 in tax, that payment must be made on the last day of the month following the end of the quarter.
You must use electronic funds transfer (EFTPS) to make FUTA payments. The FUTA tax deposits made during the year are reconciled on form 940, which is filed once annually and due January 31 for the previous year FUTA tax deposits are made quarterly; form 940 is filed annually. .
Sole proprietorships may also be subject to sales tax reporting, and each state has its own rules for sales tax. The applicable sales tax rules for your business generally can be found on your state’s Department of Revenue website. Depending on the amount of sales tax collected, the filing may need to be submitted monthly, quarterly, or annually.
If you think you may owe more than $1,000 on your personal tax return, you may need to file estimated tax payments with the IRS. The $1,000 threshold is based on all the taxes on Form 1040, not just the taxes related to Schedule C income. The amount you owe is calculated as all taxes reported on Form 1040, less any taxes withheld. Sole proprietors often must pay estimated taxes since, unlike employees, no tax is withheld during the year.
If you pay in 100% of your total prior year tax liability, you will be eligible for a safe harbor—meaning you’re guaranteed no underpayment penalty. If your prior-year income is more than $150,000, the amount you must pay is 110% of the total prior-year liability.
Rather than paying in the safe harbor amount based on prior-year tax, you can avoid an underpayment penalty by paying in 90% of your current year tax but, of course, this requires an estimate of your current year tax prior to the deadline for the first payment.
Most taxpayers use the safe harbor method to calculate their estimated payments unless they expect their current year liability to be drastically less than the prior year.
Estimated tax payments must be submitted quarterly either electronically or with Form 1040-ES by April 15, June 15, September 15, and January 15 of the following year. Form 1040-ES will help you determine the amount to submit.
Related resources:
Below you’ll find a summary of sole proprietorship tax filings:
Tax Filing | Purpose | Due Date |
|---|---|---|
Schedule C (Form 1040) | To record income and expenses of the business | April 15 (October 15 if a 6-month extension is granted) |
Form 1040 | To report an individual’s business and personal income from all sources | April 15 (October 15 if a 6-month extension is granted) |
Schedule SE (Form 1040) | To calculate self-employment tax | April 15 (October 15 if a 6-month extension is granted) |
Form 941 | To reconcile withholding on wages on a quarterly basis | April 30, July 31, October 31, and January 31 |
Form 941 Tax Deposits | To remit Social Security, Medicare, and federal withholding tax | Quarterly, monthly, semiweekly, or daily—depending on deposit schedule |
Form 940 | To report federal unemployment tax | January 31 |
Form 940 Tax Deposits | To remit federal unemployment tax collected | April 30, July 31, October 31, and January 31 |
Forms 1099 | To record nonwage payments made to vendors for $600 or more | Generally, forms must be furnished to the recipients by January 31 |
Sales Tax | To reconcile and remit tax on sales | Generally filed monthly, quarterly, or annually; visit your state’s Department of Revenue website for more detail |
1040-ES | To send estimated tax payments to the IRS | April 15, June 15, September 15, and January 15 |
Income & Deductions for Sole Proprietorships
Business income and expenses are reported on the business owner’s Schedule C of Form 1040. Generally, all ordinary and necessary expenses of running the business are deductible, but we provide some sample deductions in our IRS Business Expense Categories List.
Some additional deductions are summarized below.
1. Mileage Deduction
The mileage deduction allows sole proprietors to take a deduction for business use of vehicles. Vehicle expenses can be determined by using the standard mileage rate or actual expenses. The standard mileage rate for 2024 would result in a deduction of 67 cents per business mile. Actual expenses include items such as insurance, fees, depreciation, and gas.
To calculate the deduction for vehicle expenses using the actual expense option, you’ll need to total your actual expenses and only deduct the percentage of actual vehicle expenses that are related to the business use of the vehicle.
2. Home Office Deduction
The home office tax deduction is a way for you to take a business deduction for the area of your home that is regularly and exclusively used for business. Some examples of home office expenses include mortgage interest, rent, utilities, and repairs.
3. Sole Proprietor Tax Deductions Not on Schedule C
There are a few tax deductions that sole proprietors qualify for that are not reported on Schedule C. Since they are not deducted on Schedule C, they reduce income taxes, but not self-employment tax.
Understanding Your Tax Liability (With Example)
A reduction in Schedule C income translates to a reduction in both income and self-employment tax. Business deductions—such as phone, internet, and office supplies—reduce the income that is subject to both taxes. Tax deductions not on Schedule C discussed above only reduce income tax—not self-employment tax.
When you withdraw income from your business for personal compensation, those cash withdrawals do not count as business deductions. You are taxed on all the income and expenses of a sole proprietorship, irrespective of cash withdrawn for personal compensation.
Here is an illustration of how a sole proprietorship is taxed.
Sole P. is a graphic designer who had the following freelance activity in 2024:
- Gross receipts: $50,000
- Software subscriptions: $2,500
- Supplies: $1,500
- Advertising: $1,100
- Professional development: $1,800
- Shared workspace rent: $3,200
- Health insurance: $6,000
- Owner’s draw: $25,000
For this example, we assume that Sole doesn’t have any other sources of income and is a single filer in 2024.
Income/Expense Item | Schedule C Business Income | Nondeductible Activity | |
|---|---|---|---|
Gross Receipts | $50,000 | $50,000 | |
Software Subscriptions | <$2,500> | <$2,500> | |
Supplies | <$1,500> | <$1,500> | |
Advertising | <$1,100> | <$1,100> | |
Professional Development | <$1,800> | <$1,800> | |
Shared Workspace Rent | <$3,200> | <$3,200> | |
Health Insurance | <$6,000> | ||
Owner’s Draw | $25,000 | ||
Deduction for 50% of Self-employment Tax | <2,818> | ||
20% Pass-through Deduction | <6,216> | ||
Standard Deduction | <$14,600> | ||
Total | $39,900 | $10,266 | |
Self-employment Tax | $5,637 | ||
Income Tax - 10% Tax Rate | $1,027 |
Sole would have a total tax liability of $6,664. This total consists of $5,637 of self-employment tax plus $1,027 of federal income tax.
Notice that while Sole’s taxable income was barely over $10,000, they still had to pay over $6,500 in taxes, with $5,600 being self-employment tax. The magnitude of self-employment tax on low-income taxpayers is a shock to many new sole proprietors and must be planned for and estimated tax payments made.
Legally, a single-member LLC is a separate entity from its owner, but for tax purposes, a single-member LLC and a sole proprietorship are taxed the same way on Schedule C of Form 1040. Unlike a sole proprietorship, a single-member LLC can elect to be taxed as a C corporation (C-corp) or an S-corp, which could prove to be advantageous.
Freelancers may favor S-corp status over a sole proprietorship because of the opportunity to pay less in employment tax. As previously discussed, the self-employment tax for sole proprietors is 15.3% of all business income, regardless of the cash withdrawn from the company.
With an S-corp, the 15.3% employment tax—in this case, FICA shared by the S-corp employer and shareholder-employee—would only apply to the salary paid. This can result in tax savings when a business owner draws a salary that is less than the total business income.
To illustrate, let’s revisit the example above and assume that Sole’s business is an S-corp, and he takes a salary of $25,000 instead of an owner’s draw:
Income/Expense Item | Tax Paid on Form 1040 |
|---|---|
Gross Receipts | $50,000 |
Software Subscriptions | <$2,500> |
Supplies | <$1,500> |
Advertising | <$1,100> |
Professional Development | <$1,800> |
Shared Workspace Rent | <$3,200> |
Owner’s Salary | <$25,000> |
Employer’s FICA Tax on Wages | <$1,913> |
S-corp Income (From Schedule K-1) | $12,987 |
Wages | $25,000 |
20% Flow-through Deduction | <$2,598> |
Shareholder Health insurance | <$6,000> |
Standard Deduction | <14,600> |
Taxable Income | $14,789 |
Income Tax | $1,543 |
Employment Tax Paid on Form 941 | |
|---|---|
Wages | 25,000 |
Tax Rate (7.65% Employer; 7.65% Employee) | × 15.3% |
Total FICA Tax Paid | $3,825 |
So the total tax paid by the S-corp shareholder is the $1,543 of income tax, plus the $3,825 of FICA tax paid by the company on Form 941, for a total liability of $5,368.
Income Tax | Self-Employment / FICA Tax | Total Tax | |
|---|---|---|---|
Sole Proprietor | $1,027 | $5,637 | $6,664 |
S-corp Shareholder | $1,543 | $3,825 | $5,368 |
Tax Savings for S-corp | <$516> | $1,812 | $1,296 |
By converting to an S-corp, the sole proprietor can save $1,296 in total taxes. This amount is due entirely to employment tax savings—not income tax savings. The income tax went up mostly because of a reduced 20% pass-through deduction.
The employment tax savings occurred because the S-corp shareholder received a salary less than the total business income. If all the business income is paid out to the shareholder as salary, then there won’t be any savings.
Frequently Asked Questions (FAQs)
Most sole proprietors should pay estimated taxes of between 14.13% and 37% of business income. Of course, this is just a very rough estimate and your actual taxes will depend on your particular facts—including whether you have other non-business sources of income. Read our article on how much small businesses pay in taxes to learn more.
Nothing. As soon as you start doing side gigs and freelance work, your business is classified as a sole proprietorship. However, it’s recommended that you get an employer identification number (EIN), and your state might require you to register.
If your business has grown to the point that you need outside investment or you can no longer perform all the functions yourself, it may be time to see if another entity type would better suit your needs.
Bottom Line
Sole proprietorships offer a flexible entity structure for small businesses. They also allow for relative ease in transitioning to another entity type if business growth mandates a structural change. For more ideas on great tax strategies, read our essential tax saving tips.
