Sole Proprietorship Taxation
A sole proprietorship has a single owner. Sole proprietors must report all business income or losses on personal tax returns. The business itself is not taxed separately. This is called “pass-through” taxation. Sole proprietors pay income tax on business income. They also pay self-employment tax. The self-employment tax rate is 15.3%, inclusive of 12.4% for Social Security and 2.9% for Medicare.
Sole proprietors submit a Schedule C with their annual personal tax return. They also file Schedule SE and pay self-employment taxes quarterly. As a rule of thumb, sole proprietors should set aside 30-40% of business income to cover taxes.
Double Taxation
Double taxation means money taxed twice by the same tax. It usually refers to corporate income taxes on earnings and dividends. Corporations are viewed as separate legal entities from shareholders. They pay taxes on annual earnings. Shareholders pay personal income taxes on dividends. Trying to avoid double taxation is common.
Self-Employment Taxes
Self-employment taxes are in addition to income taxes, with everyone required to pay Social Security and Medicare taxes. When self-employed, you pay both portions of these taxes, totaling 15.3%.
The IRS requires self-employed taxpayers expecting to owe more than $1,000 in self-employment tax to make estimated tax payments quarterly using IRS Form 1040.
Self-employed workers pay both the employee and employer portions of Social Security taxes, leading to a double taxation rate compared to employees.
You must pay self-employment taxes if you made $400 or more in net earnings from self-employment. This includes income as a business owner, freelancer, or independent contractor.
Self-Employment Tax Process
A sole proprietor submits Schedule C with their personal 1040 tax return yearly. They also file Schedule SE and pay quarterly self-employment taxes. Sole proprietors must pay the full Social Security and Medicare taxes themselves, with a total self-employment tax rate of 15.3%.
Payments on account are made twice a year by self-employed taxpayers to spread the upcoming year’s tax cost based on the previous year’s tax bill.
Self-employment taxes fund Social Security and Medicare programs. Employees pay similar taxes through withholding, while employers also contribute. Self-employed individuals must pay all these taxes themselves.