Sole Proprietorship Taxes
In comparison to other business models, sole proprietorships (managed by freelancers, consultants, or other independent contractors) often have straightforward taxes. But, when tax season arrives, single owners must adhere to particular tax standards.
Sole proprietorship taxes differ from that of other business entities, such as corporations, in that the business is not taxed separately from the business owner. Instead, your single proprietorship taxes are reported and paid as part of your personal tax return.
Sole proprietorship taxes are calculated based on your net profit (income minus expenses), whether you have employees, and whether you pay local and state taxes.
When your business income exceeds your expenses, you must pay self-employment taxes on your net gains. For 2022, the self-employment tax rate is 15.3%, divided into two parts:
Social Security tax: 12.4%
Medicare tax: 2.9%
In 2022, the first $147,000 of your combined salaries, tips, and net profits are subject to Social Security taxes, while the rest of your earnings are subject to Medicare taxes. In addition, if your combined income surpasses $200,000 in 2022, you will be subject to an extra Medicare tax rate of 0.09%.
In general, the percentage of your net profit that is liable to self-employment tax is 92.35%. For example, if your sole proprietorship made a $50,000 net profit, you'll pay $7,065, which is 15.3% of $46,175 ($50,000 x 92.35%).
There are however other circumstances in which you are not required to pay self-employment taxes, such as if your net profits for the taxable year were less than $400.
You must pay income taxes on your net profits in addition to self-employment taxes. Depending on where you live, this may include both federal and state taxes.
The amount of federal income tax you owe is determined by your federal income tax bracket. The federal tax brackets are as follows: 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
The state in which you live or earn your income also influences whether or not you must pay state income taxes. Certain states, such as Washington, Florida, and Texas, do not levy state income taxes.
If you recruit staff for your firm, you will have to pay employment taxes in addition to self-employment, federal and state income taxes.
Employers must generally withhold and deposit the following for their employees:
- Income taxes, both federal and state
- FICA (Federal Insurance Contributions Act) taxes
- Employees are subject to Federal Unemployment Tax Act (FUTA) levies.
- It's also worth noting that as a sole proprietor, you can't treat yourself as an employee of your company.
Knowing your deductions is critical as a lone proprietor. Because you are only taxed on your net profits, it is advantageous to take use of any tax deductions.
The following are common tax deductions for lone proprietors:
- Taxes on self-employment
- Health-care coverage
- Business travel expenses
- Restaurant dinners for business
- Advertising expenses
- Rent and lease expenses
- Deduction for home office
- Mobile phone
It's always a good idea to consult with a tax professional about your sole proprietorship and the deductions that may be available to you.