Being a sole proprietor means you have to know and handle your taxes. Let’s go over the taxes a sole proprietor has to pay and some tax deductions for sole proprietors. Remember, the majority of self-employed are
What Taxes Does A Sole Proprietor Pay?
Income taxes are the largest tax burden for most sole proprietors. The vast majority of small businesses are sole proprietorships owned by a single individual.
Others can be “pass-through entities” for tax purposes. That is, limited liability companies (LLCs), partnerships, or S corporations. None of these businesses pay any tax themselves. The owner reports the profits or losses on their tax returns and tax paid at their individual income tax rates.
Along with federal income taxes, you can also pay state income taxes on your small business. The exceptions are Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. New Hampshire and Tennessee impose income taxes on dividend and interest income only.
Federal income tax rates are much higher than those of the states. Federal individual income tax rates range from 10% to 39.6%. Most states charge a percentage of the income shown on your federal income return. Depending on the state in which you live, these percentages range anywhere from 3% to 12%. Each state has its own income tax forms and procedures.
Businesses established as regular “C” corporations are separate taxpaying entities. These entities have to file their own income tax returns, with their own tax rates. The federal corporate tax rates are less than the individual rates are lower income levels, ranging from 15% to 35%. Most states impose their own taxes on such corporations.
What Can I Write Off As A Sole Proprietor?
You can deduct almost all of your legitimate business expenses. This is important because write-offs potentially lower your taxable income, which could mean paying less in taxes. Remember, you don’t pay taxes on your gross income, just on the net profit left after subtracting your deductions from your gross income.
The major business expenses are:
- Startup expenses
- Operating expenses
- Capital expenses, and
- Inventory costs.
How Much Can I Write Off For Startup Costs?
You may deduct up to $5,000 in startup costs the first year a new business is in operation. You may deduct amounts of more than $5,000 over the next 15 years. These include most of the costs of getting your business up and running. This can include things like license fees, advertising costs, attorney and accounting fees.
What Are Operating Expenses?
Operating expenses are the ongoing day-to-day costs a business incurs to stay in business. These expenses are currently deductible. That is, you can deduct them all in the same year when you pay them. This includes things like rent, utilities, salaries, supplies, travel and more.
What Are Capital Expenses?
Capital assets are things you buy for your business that have a useful life of more than one year. This includes purchases like land, buildings, equipment, vehicles, books and more. These are considered part of your investment in your business.
You must deduct the cost of these items a little at a time over many years. This process is called depreciation. Yet, small businesses can usually deduct the cost of long-term assets much more quickly.
What Are Inventory Costs?
Inventory includes almost anything you make or buy to resell to customers. Inventory doesn’t include tools, equipment, or other items that you use in your business. It refers only to items that you buy or make to sell.
You must deduct inventory costs separately from all other business expenses. You deduct inventory costs as you sell the inventory. Inventory that remains unsold at the end of the year is a business asset, not a deductible expense.
Social Security and Medicare Taxes
Everyone who works must pay Social Security and Medicare taxes. Employees pay one-half of these taxes through payroll deductions. The employer must pony up the other half and send the entire payment to the IRS.
Business owners must pay all these taxes themselves. These are included in the quarterly estimated taxes sole proprietors, partners in partnerships, and LLC owners pay to the IRS each year.
The Social Security tax is a flat 12.4% tax up to an annual income ceiling which is adjusted for inflation each year. In 2017, the ceiling was $127,000. There are two Medicare tax rates: a 2.9% tax up to an annual ceiling: $200,000 for single taxpayers and $250,000 for married couples filing jointly. All income above the ceiling is taxed at a 3.8% rate.
What Payroll Taxes Do I Have to Pay?
If you hire employees to help you in your business, you’ll have to pay payroll taxes. These consist of half of your employees’ Social Security and Medicare taxes and all of their federal unemployment tax. You must also withhold the other half of your employees’ Social Security medicare taxes. Also, you must withhold all their income taxes from their paychecks,
You must pay these taxes monthly or bi-monthly by electronic deposit to the IRS. You’ll have to keep records and file quarterly and annual employment tax returns with the IRS.
When you hire independent contractors you don’t have to pay any employment taxes. You need only report payments over $600 for business-related services to the IRS. You’ll also report that to your state tax department if your state has income taxes.
If you live in a state with income taxes and you have employees, you’ll likely have to withhold state income taxes from their paychecks and send the money to your state tax department. You’ll also have to provide your employees with unemployment compensation insurance by paying taxes to your state unemployment compensation agency.
What Sales Taxes Do I Have to Pay?
Almost all states and many municipalities impose sales taxes of some kind. The only states without a sales tax are Alaska, Delaware, Montana, New Hampshire, and Oregon. Alaska permits local sales taxes).
Other State and Local Taxes
Various states and localities impose a hodgepodge of other taxes on businesses. These can range from taxes on business property and/or inventory, to excise taxes on business income.
MileIQ’s blog does not constitute professional tax advice. You should contact your own tax professional to discuss your situation.