Tax Reporting for Sole Proprietors

By Consumer Dummies

The federal government doesn’t consider sole proprietorships to be individual legal entities, so they’re not taxed as such. Instead, sole proprietors report any business earnings on their individual tax returns — that’s the only financial reporting they must do.

Most sole proprietors file their business tax obligations as part of their individual 1040 tax return by using the additional two-page form Schedule C, Profit or Loss from Business. You can download the latest version of Schedule C.

Sole proprietors must also pay the so-called self-employment tax — which means paying both the employee and the employer sides of Social Security and Medicare. That’s a total of 15.3%, or double what an employee would normally pay, and it is a bummer for sole proprietors. The following table shows the drastic difference in these types of tax obligations for sole proprietors.

Comparison of Tax Obligations for Sole Proprietors
Type of Tax Amount Taken from Employees Amount Paid by Sole Proprietors
Social Security 6.2% 12.4%
Medicare 1.45% 2.9%

Social Security and Medicare taxes are based on the net profit of the small business, not the gross profit, which means that you calculate the tax after you’ve subtracted all costs and expenses from your revenue. To help you figure out the tax amounts you owe on behalf of your business, use IRS form Schedule SE, Self-Employment Tax. On the first page of this form, you report your income sources and on the second page, you calculate the tax due. You can download a copy of Schedule SE.

As the bookkeeper for a sole proprietor, you’re probably responsible for pulling together the Income, Cost of Goods Sold, and Expense information needed for this form. In most cases, you then hand off this information to the business’s accountant to fill out all the required forms.

As a sole proprietor, you can choose to file as a corporation even if you aren’t legally incorporated. You may want to do so because corporations have more allowable deductions and you can pay yourself a salary, but it requires a lot of extra paperwork, and your accountant’s fees will be much higher if you decide to file as a corporation. However, because corporations pay taxes on the separate legal entity, this option may not make sense for your business. Talk with your accountant to determine the best tax structure for your business.

If you do decide to report your business income as a separate corporate entity, you must file Form 8832, Entity Classification Election with the IRS. This form reclassifies the business, a step that’s necessary because the IRS automatically classifies a business owned by one person as a sole proprietorship. You can download the most current version of the form.