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According to the U.S. Government Accountability Office (GAO), most sole proprietors underreport their income each year, which often leads to underpaying taxes. They do that not out of the desire to evade taxes. GAO’s research revealed that sole proprietors find the current tax guidance too technical and confusing. This can cause unintentional inaccuracies or omissions in tax returns.
To help you understand how sole proprietorship taxes work, this blog post reveals:
A sole proprietorship is a business owned and operated by a single individual, known as a sole proprietor. It’s an unincorporated business that isn’t legally separate from its owner.
Because the law treats a sole proprietorship and its owner as the same legal entity, any debts or lawsuits the organization faces are your responsibility. That means if the firm can’t pay its debts, creditors can go after both your personal assets (like your house) and business properties.
Setting up a sole proprietorship is easy because you don’t have to file formation paperwork, although you still need relevant licenses and permits to operate legally. It also doesn’t have as many regulatory requirements as other types of business structures, making it a popular choice for small and mid-size organizations.
According to the U.S. Small Business Administration, an organization is automatically considered a sole proprietorship if it does trading activities without registering as any other kind of business (limited liability company or partnership, for instance).
In a sole proprietorship, the Internal Revenue Service (IRS) treats you and your organization as one, so the business itself doesn’t pay income tax. Instead, you report business income and expenses on your personal tax returns — a system called pass-through taxation. This setup reduces paperwork and prevents double taxation, where income gets taxed at both the business and personal levels.
Before filing your tax return, you first determine your taxable income. As a sole proprietor, the IRS doesn’t tax your gross revenue. You only pay taxes on business profits — total revenue minus business expenses.
When calculating your taxable income, you deduct the cost of operating your business. But not all expenses are 100% deductible. For example, the IRS allows you to deduct only 50% of business meal expenses.
Besides operating expenses, multiple special deductions can reduce sole proprietorship tax liability. Unfortunately, they are often overlooked, and small business owners who don’t take advantage of them pay more than they owe. Below are deductions that can lower your taxable income:
Sole proprietors can take advantage of self-employed health insurance deductions to reduce their tax burden. The IRS allows you to deduct the medical care premium you pay for a policy that covers you, your spouse, or dependents like your children.
With healthcare insurance costs increasing in the U.S., these deductions can be a great opportunity to lower your tax bill.
If you use your car for business, you may be eligible for mileage deductions. For every mile you use your vehicle in business operations, the IRS sets a standard rate you can deduct from your tax returns. The rate changes over time — for 2025, it’s 70 cents a mile.
Seventy cents a mile might seem insignificant, but the amount can add up quickly if you look at the bigger picture. If you drive 15,000 miles a year for work, for example, that’s a whole $10,500 you can deduct from your 2025 taxable income.
As with any other IRS-related procedures, the agency will require solid evidence that verifies the deductions. You’ll need evidence that:
To ensure accurate record-keeping, use uAttend to streamline employee timekeeping and payroll tracking, reducing the chances of errors when reporting deductions. uAttend with its payroll processing capabilities also helps simplify mileage reimbursement, ensuring compliance with IRS guidelines.
The two basic requirements for your home office to qualify as a deduction are:
If your sole proprietorship is eligible, you can calculate home office expense deductions at the rate of $5 per square foot for the home space you’re using for business. The IRS allows you to claim home office deductions for up to 300 square feet. The maximum deductions under this calculation method are $1,500.
After subtracting all applicable deductions from your income, the remaining portion is your taxable income. How much you owe the IRS depends on the tax bracket your taxable income falls into. To ensure compliance with tax laws, it’s important to stay up to date with payroll regulations. Check out our guide on The 4 Types of Payroll Compliance: A Comprehensive Guide to avoid common payroll mistakes.
Apart from income tax, other taxes you may have to pay as a sole proprietor include:
In a typical organization, the employer withholds the following taxes from employees’ salaries:
Self-employment tax is Social Security and Medicare taxes for people who work for themselves, including independent contractors and sole proprietors. You must pay this tax if your net income from self-employment is at least $400. The current self-employment rate is 15.3% of the net income in your sole proprietorship —12.4% for Social Security and 2.9 % for Medicare.
An employer pays half of an employee’s Social Security and Medicare taxes while the other half is withheld from the person’s paycheck. Sole proprietors pay 100% of these taxes. However, you can deduct 50% of your self-employment taxes from your taxable income.
Estimated taxes are periodic payments that sole proprietors make to the IRS throughout the year to cover their tax obligations. Unlike traditional employees, sole proprietors don’t have someone to withhold taxes from their income. So, they must pay the IRS in installments.
Sole proprietors who expect to owe tax of at least $1,000 must pay estimated tax. But how do you calculate estimated tax?
You approximate your total tax liability for a particular year, including your income and self-employment taxes. Next, divide the amount into four quarterly payments. Each period has a deadline. Late payments attract an IRS penalty.
All of the above are federal taxes. Other taxes like state income tax and sales tax may apply, depending on your location.
The type of sole proprietorship tax you’re reporting will determine the IRS form you should use.
Type of Tax | The IRS Form to Use |
Income Tax | Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship) |
Self-employment tax | |
Estimated tax |
If you have employees, you’ll need to withhold income, Social Security, and Medicare taxes from their paychecks. To do that, your workers must first fill out Form W-4 to help you determine how much federal income tax you need to withhold from their salaries. For each employee, keep this form on your records.
To report income tax, Social Security, and Medicare withheld from employees’ wages, you’re required to file Form 941, Employer’s Quarterly Federal Tax Return. If you report taxes once a year instead of quarterly, you file Form 944, Employer’s Annual Federal Tax Return.
A single-member LLC is a limited liability company with just one owner (known as a member). It’s an alternative to sole proprietorship but with key differences.
A single-member LLC protects you from personal liability. That means the company is separate from the owner unlike in sole proprietorship. So when the business is in debt, creditors can’t come after your personal stuff like your house or car. In short, you’re not personally liable for the company’s debts and legal obligations.
A single-member LLC offers flexibility in taxation. By default, the IRS taxes this type of business as a sole proprietorship. But the owner can choose to be taxed as a C corporation or S corporation (S corp).
Being taxed as an S corporation lowers the self-employment tax rate. An S-corp prevents double taxation because it is a pass-through entity that isn’t taxed at the business level. It also allows the owner to deduct losses on personal income taxes, minimizing your tax liability.
Sole proprietors can take advantage of the following sole proprietorship tax deductions:
To deduce vehicle expenses from your sole proprietorship tax return, you must determine the cost of operating the car for business operations. Deductible expenses include:
Maintaining accurate records is essential to substantiate these expenses. uAttend can assist in tracking and documenting these costs efficiently, ensuring compliance with IRS regulations.
Qualified business income (QBI) is the net income or loss in a qualified trade or business. The IRS allows select businesses, including sole proprietorships, to deduct up to 20% of their QBI from their taxable income.
With uAttend’s automated time tracking already simplifying workforce management, getting started with fully integrated payroll in uAttend takes automation even further. It seamlessly handles tax calculations, deductions, and payroll compliance, ensuring accuracy while saving you time. Built-in compliance tools help track payroll-related deductions and meet tax filing deadlines, reducing the risk of penalties or errors. Book a demo today to see how uAttend Payroll works alongside your time tracking to eliminate manual payroll tasks and keep your business compliant.
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