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Sole Proprietorship Taxes: A Guide to Deductions and Filing

December 4, 2024

Sole proprietors have unique tax considerations to make when compared to other types of business entities. Because sole proprietorships aren’t taxed separately from the business owner, sole proprietor taxes are a part of the owner’s personal tax return. This is known as pass-through taxation since the tax liability passes through the business and onto the owner. To file taxes as a sole proprietor, you must complete Schedule C as a part of your personal income tax return, Form 1040.

As a sole proprietor, the net income from your business will increase your personal tax income, potentially placing you into a higher tax bracket. You also can’t claim the total amount of the taxes you pay as a sole proprietor as business expenses, which is different from taxes for other types of business owners.

These are just some of the tax details you’ll need to understand to properly file taxes as a sole proprietor. In this guide, we’ll cover everything you need to know about paying taxes as a sole proprietor, including reporting income and expenses, the different kinds of tax deductions you can claim, and the unique filing requirements you’re subject to. Let’s take a look.

Key Takeaways

Sole proprietors pay taxes via pass-through taxation, meaning the IRS applies the business income to the sole proprietor’s individual income taxes, potentially placing them in a higher tax bracket.
To file taxes as a sole proprietor, you must complete Schedule C (for business expenses and income) alongside your Form 1040 and Schedule SE.
Sole proprietors might be subject to other taxes, including payroll taxes (if you have employees), property taxes (if your business owns real estate), and sales and excise taxes.
Sole proprietors can deduct expenses to help offset their tax liability, including health insurance, business mileage, home office expenses, and 50% of their self-employment taxes paid.
Most sole proprietors must file their taxes annually on April 15 and certain forms (such as Form 941) quarterly. You’ll also be required to pay quarterly estimated tax payments.

Table of Contents

How Is Sole Proprietorship Taxed?
How to File Taxes as a Sole Proprietor
Tax Deductions for Sole Proprietorships
Filing Deadlines for Sole Proprietorship Taxes
How FreshBooks Simplifies Tax Filing for Sole Proprietors
FAQs About Sole Proprietorship Taxes

How Is Sole Proprietorship Taxed?

Sole proprietorships are taxed via pass-through taxation, meaning their tax liability carries through the business and onto their individual income tax return. In the eyes of the law, the sole proprietorship and its owner are the same. This means that any financial activity from your business carries directly over to your personal income tax return, affecting your taxable income and potentially placing you into a higher tax bracket.

As a sole proprietor, you must also pay 15.3% of your income as self-employment tax, which funds Social Security and Medicare. Usually, employees and their employers split this amount (FICA taxes), but you’ll have to pay the total amount as a sole proprietor—at least at first. You can later deduct 50% of your self-employment taxes to bring it in line with what you’d be paying as a W-2 employee.

While sole proprietorships raise your personal tax liability, there are also advantages to being a sole proprietor. Business expenses can be directly deducted from your individual tax return, offsetting your tax bill and lowering the amount you owe. You can also claim several specifically designed tax deductions, which help lower income tax for sole proprietors.

How to File Taxes as a Sole Proprietor

How do you go about properly filing taxes as a sole proprietor? You’ll need to follow a few steps closely to ensure compliance and reduce your taxable income as much as possible. Here’s what you need to know.

Schedule C

Schedule C is one of the most important tax forms for sole proprietorships. If applicable, you’ll use this form to report your business’s income, expenses, and business mileage (if applicable).

Fortunately, this form is pretty straightforward to complete. It’s broken up into 5 main sections, allowing you to report your income, expenses, cost of goods sold (if applicable), information on your business vehicle, and any other expenses your sole proprietorship has incurred over the tax year. You should be able to complete this form by referencing your past year’s financial statements and, if applicable, your mileage tracking app of choice.

Your Schedule C will also ask questions about your business’s accounting method. You’ll usually want to select cash basis (unless instructed otherwise by a tax expert) to ensure the government taxes you only on the income your business received.

You’ll use your Schedule C to complete your individual 1040 tax return and determine your sole proprietorship tax rate, so we recommend doing this form first.

Schedule SE

Schedule SE is the IRS form used to calculate your self-employment tax liability. These taxes pay for your share of Social Security and Medicare at 15.3% of your gross income. Remember that while you only need to file Schedule SE (along with Schedule C and Form 1040) annually, you’ll be responsible for paying self-employment taxes quarterly through estimated payments. You can calculate estimated taxes using Form 1040-ES.

Schedule SE will be instrumental in completing your Form 1040 individual income tax return. At that point, you can deduct half of the self-employment taxes you’ve paid from your overall tax liability.

Additional Taxes

Depending on the type of business you run as a sole proprietor, you might be subject to a few other taxes.

Employment Taxes

Otherwise known as payroll taxes, any business (including sole proprietorships) that employs workers must pay this tax. This involves withholding FICA taxes (for Social Security and Medicare) and unemployment taxes from employee paychecks and paying your share of employment taxes when required. You’ll use Form 940 and Form 941 to report and pay employment taxes. You’ll also need to file Form W-2 annually for each employee to report their wages and tax withholdings or Form 1099 for each independent contractor.

Property Taxes

You’ll possibly be subject to paying property taxes for sole proprietorships that own business property. These taxes are on the state or local level and vary depending on the location of your sole proprietorship. We suggest double-checking with your local tax authority for information on your property tax obligations.

Sales and Excise Taxes

Depending on the nature and location of your sole proprietorship, you might have to pay certain sales taxes. Like property taxes, these vary by location. Most states require you to pay sales tax on any goods or services you sell through your business—your state tax authority can provide more information on your obligations.

Excise taxes only apply to businesses that sell certain taxable products, such as alcohol or tobacco. Unlike sales taxes, you pay excise taxes at the local, state, and federal levels, so make sure you understand your excise tax requirements.

LLCs Taxed as a Sole Proprietorship

You might have to pay pass-through taxes as a sole proprietor, even if your business is a limited liability company or LLC. An LLC is a legal status at the state level but not at the federal level. This means that single-member LLCs are still considered sole proprietors and pay federal income tax accordingly. If your LLC has 2 or more members, the government classifies it instead as a partnership with different tax implications. Whether your business is a single-member LLC or a multi-member one, you can file taxes as a corporation rather than a sole proprietorship by completing IRS Form 8832.

Tax Deductions for Sole Proprietorships

Sole proprietorships face several unique tax obligations. However, there are also some advantages to this business structure—namely, the deductible business expenses you can claim on your individual tax return. Here are the deductions for sole proprietors to be aware of.

Health Insurance Deduction

As a sole proprietor, you may not realize you can deduct the health insurance premiums you, your spouse, and your dependents pay from your taxes. You also don’t need to itemize your tax return to claim a self-employed health insurance deduction, making this a simple deduction to receive. Health insurance premiums are considered an “above the line” deduction for sole proprietors, meaning you deduct them before calculating your adjusted gross income (AGI), which the IRS uses to determine your taxable income. Remember that you can only claim this deduction if neither you nor your spouse are eligible to receive health insurance coverage through a group insurance plan.

Business Mileage Deduction

Like other business taxpayers, sole proprietors can claim a business mileage deduction to offset their income tax liability. For 2024, the standard mileage rate is $0.67 per mile, which can add up quickly if you frequently drive a vehicle while operating your sole proprietorship. You’ll have to itemize your mileage records carefully to claim this deduction, but the potential savings make it well worth it for sole proprietorships.

Home Office Deduction

If you run your business partially or entirely out of your home, you can claim a deduction for your home office expenses, which can significantly reduce your taxable income. To claim a home office deduction, you must calculate the size of the area of your home used exclusively for business, which you can express as a percentage and use to deduct part of various expenses, such as rent, mortgage interest, property taxes, home insurance, utilities, repairs, maintenance, and more.

You can claim your actual expenses related to your home office by multiplying the percentage of your home used for business by your total home expenses. To claim a home office deduction with this method, you’ll have to file IRS Form 8829. Alternatively, you can claim the standard home office deduction of $5 for every square foot of your home office (up to 300 square feet), which doesn’t require any additional forms.

Self-Employment Tax

Sole proprietors must pay 15.3% of their business income in self-employment tax, which covers their share of Social Security and Medicare taxes. However, to make self-employment taxes equitable with the amounts paid by W-2 employees (who split this self-employment tax rate evenly with their employer through FICA payroll taxes), you can claim a deduction for 50% of the self-employment taxes you pay, meaning your actual tax liability is just 7.65%.

Filing Deadlines for Sole Proprietorship Taxes

The deadlines for sole proprietorship taxes depend on the tax in question. For instance, some forms, like Form 1040 and the accompanying Schedule C, must be filed annually on the same schedule as your personal tax return—April 15, 2025, or Oct. 15, 2025, if you file for an extension from the IRS. 1 Remember that even if you file an extension, you must pay all tax obligations on or before April 15. On the other hand, you must file Form 941 (for calculating payroll taxes) quarterly, and you’ll also have to pay your quarterly estimated taxes (calculated using Schedule SE) quarterly. 2

Failing to meet these deadlines can result in harsh penalties from the IRS, causing you to pay much more than if you were to file these tax forms on time.

How FreshBooks Simplifies Tax Filing for Sole Proprietors

Sole proprietors are typically busy professionals balancing many responsibilities simultaneously. If this sounds like you, FreshBooks expense-tracking software is here to help.

FreshBooks software is for busy sole proprietors looking to spend less time on administrative tax work and more time focusing on their business. Our expense-tracking software streamlines the process, automating many time-consuming calculations to ensure accurate tracking throughout the year. Plus, FreshBooks makes generating the financial reports you need simple, perfect for tax compliance and keeping your finances healthy.

Discover why so many sole proprietors trust FreshBooks expense-tracking software to manage their taxes efficiently. Try FreshBooks for free!

FAQs About Sole Proprietorship Taxes

Still curious about the unique tax requirements for sole proprietors? Here’s some more information to help.

What Are the Tax Advantages of a Sole Proprietorship?

One of the main tax advantages for sole proprietors is that there is no double taxation. With some types of corporations, the IRS taxes earnings once at the corporate level and again at the individual level on dividends. Because all business income is passed through to the sole proprietor’s individual income tax rate, they avoid paying taxes on earnings more than once.

How Much Can a Sole Proprietor Make Without Paying Taxes?

Any business income above $400 a sole proprietorship generates is taxable by the IRS. To comply with tax law, you must report and pay it.

Is Sole Proprietor or LLC Better for Taxes?

LLCs often pay fewer taxes than sole proprietors, but this isn’t always true. Plus, when you factor in the fees and other costs associated with running an LLC, you might not save as much in reality as expected.

What Expenses Cannot Be Deducted by a Sole Proprietor?

Anything considered a personal, living, or family expense isn’t deductible for sole proprietorships. This includes many taxes, fines and penalties, capital expenses and equipment, commuting costs, and anything you pay for that isn’t related to operating your sole proprietorship.

How Much Can a Sole Proprietor Write Off?

Sole proprietorships, if eligible, can deduct up to 20% of their income as a qualified business income (QBI) deduction. Qualified business income generally means your net business income minus specific exclusions.

ARTICLE SOURCES:

Michelle Payne, CPA

About the author

Michelle Payne has 15 years of experience as a Certified Public Accountant with a strong background in audit, tax, and consulting services. Michelle earned a Bachelor’s of Science and Accounting from Minnesota State University and has provided accounting support across a variety of industries, including retail, manufacturing, higher education, and professional services. She has more than five years of experience working with non-profit organizations in a finance capacity. Keep up with Michelle’s CPA career — and ultramarathoning endeavors — on LinkedIn.