A sole proprietorship is the simplest business structure in the United States. It’s easy to navigate everything from starting your business to filing taxes when you’re a sole proprietor. When it comes to sole proprietorship taxes, however, that simplicity can have costs in the form of fewer business tax breaks.
If you use this business structure, here’s what you should know about sole proprietorships and taxes. We’ll cover the basics of how sole prop taxes work, what tax forms you need to file, and the IRS’s deadlines. Ultimately, you may find that a limited liability company (LLC) would afford more tax benefits, the answer depends on your profits and operations.
How are sole proprietorships taxed?
To the IRS, a sole proprietorship is a “disregarded entity.” Unfortunately, this doesn’t mean the agency ignores.
“Disregarded entity” means that to the IRS, the business is not a separate entity for federal income tax purposes. You and your sole proprietorship are taxed together, as one.
(States typically follow the IRS on most sole proprietorship tax matters, and most federal business tax rules in general.)
Pass-through taxation explained
The main way that this is expressed comes in the form of “pass-through taxation.” Profits and losses pass straight through to you rather than being taxed at a business level first.
This is different from how corporations are taxed. A corporation pays its own business taxes, and then members (owners) and employees pay personal income tax on the moneys they receive. Critics sometimes refer to this as “double taxation.”
Note: Pass-through taxation doesn’t exempt you from filing business tax forms. You still need to file the appropriate forms (usually Schedule C, see below), in order to show the business’s profits/losses. The amount from Schedule C is then copied onto your Form 1040 personal income tax filing.
Self-employment tax
Pass-through treatment simply means that you and your sole proprietorship are taxed as one. It doesn’t mean there are no business deductions allowed, or additional taxes assessed. Sole proprietors must pay self-employment tax (assuming profits are at least $400).
Self-employment tax takes the place of payroll taxes. Both cover Social Security and Medicaid taxes:
- Payroll Taxes: Employees and employers normally split these taxes 50-50. Employees pay half of the Social Security and Medicaid taxes, and employers pay half. (Small adjustments for high-income earners, and for unemployment taxes.)
- For 2026, the total employee responsibility (FICA) is 7.65%. This breaks down to 6.2% Social Security taxes and 1.45% Medicare taxes. The appropriate amount is usually deducted from each paycheck.
- Self-Employment Taxes: Self-employment taxes take the place of payroll taxes. Sole proprietors are responsible for both the employee’s and the employer’s share.
- The 2026 self-employment tax rate is 15.3%, breaking down as 12.4% Social Security and 2.9% Medicare. (Social Security taxes are capped at $184,500 of income; there is no cap for Medicare taxes.) Payment is due quarterly via estimated payments (see below).
For entrepreneurs just starting a small business, self-employment taxes can be quite a shock. Not setting aside savings to pay them results in cash flow crunches, and fees and interest add up if the taxes aren’t paid on time.
There is a silver lining, in that the IRS lets you deduct one-half of the self-employment tax when figuring adjusted gross income. This deduction is significantly smaller than the tax, though.
(Most states have self-employment tax and income tax rules that follow the IRS’s, with lower rates.)
Income tax obligations
Sole proprietors are still subject to standard personal income tax. These are the same federal income tax rates that everyone pays: 10%, 12%, 22%, 24%, 32%, 35% an 37% (plus any state income tax). Since a sole proprietorship isn’t itself directly taxed, there aren’t any separate corporate tax rates to look up.
Because the business and individual are treated as one entity, you’ll pay income tax on all net profits from the business. This is true regardless of whether you withdraw them to a personal checking account, or leave them in a business bank account. (Conversely, you can deduct net losses against your personal income.)
Your net profits are calculated on Schedule C, and then the total amount is carried over onto your 1040.
(It’s a best practice to always separate your personal finances and business finances. This keeps bookkeeping easier, and ensures things are clearer if you’re ever audited.)
Quarterly estimated tax payments
Since most sole proprietors don’t have taxes withheld from paychecks, the IRS uses a pay-as-you-go system. You generally need to file estimated tax payments throughout the year, so long as you expect to owe at least $1,000 in taxes when filing your annual return.
Estimated tax payments can be made with Form 1040-ES. The standard due dates are April 15 (for Q1), June 15 (for Q1), September 15 (for Q3), and January 15 of the following year (for Q4).
Failure to pay enough throughout the year can result in underpayment penalties, no matter if you pay the full annual amount due by next year’s April 15 deadline.
Note: Payment of some estimated taxes due is better than payment of none. Pay future quarters even if you missed previous quarters. Pay some of a quarter even if you can’t pay all. This will lessen the underpayment penalties.
Sole proprietorship tax forms
Compliance is all about the paperwork. While you don’t file a separate business return, you do have to add specific schedules to your personal 1040 income tax form.
Schedule C (Form 1040)
Schedule C is the first main sole proprietorship tax form. The IRS uses Schedule C to report income or loss from a business you operated as a sole proprietor. It’s attached to your personal Form 1040, and is where you list gross receipts, deductible expenses, and the resulting net profit or net loss.
Schedule C will guide you through most common sole proprietor business deductions, such as supplies, contract labor, advertising costs, and other expenses. Be sure to keep accurate books, so you have the necessary information easily accessible.
(Most states rely on the same types of forms as the IRS uses.)
Schedule SE
Schedule SE is the second main sole proprietorship tax form. This is where your Social Security and Medicare taxes get calculated, in the form of self-employment tax. The form:
- Calculates your self-employment tax
- Accounts for any estimated tax payments made
- Applies the one-half deduction allowed for these taxes
Form Schedule SE is required if you make at least $400 in net profits during the year.
Whereas Schedule C measures business profit, Schedule SE measures the Social Security and Medicare tax tied to that profit.
Forms for sole proprietors with employees
If you rely on additional workers, additional business tax forms must be filed. These include:
- Form 941: For payroll taxes; filed quarterly.
- Form 940: For federal unemployment (FUTA) taxes; filed annually.
- W-2s: For your employees on their tax returns; issued annually.
- 1099-NEC: For independent contractors paid $600 or more in a year; issued annually.
If you only hire independent contractors, Form 1099-NEC is the only worker-related tax form you need is 1099-NEC. If you have employees, Form 941, Form 940 and W-2s are required.
(You’ll also need an employer identification number (EIN) if hiring employees, and it’s strongly recommended if hiring independent contractors.)
Sole proprietorship taxes for small business
The taxes for sole proprietorships can seem high, and they indeed are more than what employees pay. There are multiple deductions available to solo business owners, though.
How sole proprietor deductions work
Deductions reduce your amount of taxable income, which in turn reduces your tax obligation. Your taxes due are not reduced by the amount of the deduction. They’re reduced by the taxes that you’d otherwise pay on the deductible amount.
For a vastly simplified example, consider a sole proprietor that earns $1,000 and pays a single 10% tax. Their standard tax liability would be $100 ($1,000 x 10%). If they have a $50 deduction, the taxes due would be $95 (($1,000 – $50)) x 10%) and not only $50.
Even though deductions only reduce taxable earnings, they still can save you a lot on taxes. Take advantage of any that you qualify for.
Common tax deductions
Common tax deductions generally include things that are necessary for the operation of your business. Some that you may qualify for are:
- Home Office Deduction: A space in your house that’s exclusively used as a home office. A simplified method applies $5 per square foot up to 300 sq. ft., or you can calculate actual expenses.
- Business Mileage Deduction: Mileage driven for work-related purposes. Standard rate is 72.5 cents per mile, or you can calculate actual expenses. If you use the same vehicle for both work and personal driving, keep accurate records showing what miles were driven for the business.
- Equipment and Supplies: Any equipment and supplies that are used for your business. If you use something for both work and personal, estimate how much it’s used for work and deduct that percentage of the cost. Smaller expenses might be deducted immediately, while larger purchases may be amortized over several (e.g. 5) years. Keep receipts.
- Internet and Phone: Internet and phone costs are deductible if used for work. Assuming you use your phone and internet for both work and personal, deduct the estimated amount that they’re used for work. Keep monthly bills.
- Marketing and Advertising: Any marketing and advertising expenses are deductible. Some sole proprietors have none, while others have a significant amount.
- Professional Services: Professional services include most anything you pay to outsource. Payments to independent contractors fit here.
- Qualified Business Income (QBI) Deduction: Under Section 199A, sole proprietors can deduct up to 20% of their qualified business income. (Phases out for high-income earners.)
- Health Insurance Premiums: If you are self-employed and not eligible for an employer-sponsored plan (including through a spouse), you can often deduct your health insurance premiums. This isn’t necessarily a true business deduction, but is one available to most solo business owners.
Some of the documents you’ll want to keep are noted above, but not all that you’ll need. Keep accurate records of all expenses you plan to deduct.
State and local tax considerations
In addition to federal taxes, you’re likely also subject to state and local taxes. Most states have income taxes, sales tax and employment taxes, and some states have other taxes for sole proprietors. The most common local taxes are sales tax and a general business permit fee.
State and local tax obligations vary both by business type, and by jurisdiction. Check with the agency in your state that oversees businesses to check what state taxes apply. Your municipal clerk and county clerk will know what local taxes apply. Don’t make the mistake of assuming you’re exempt as a sole proprietor, because you almost certainly aren’t.
Tax planning considerations for small businesses
Properly preparing for filing taxes ensures you have the records necessary to accurately report profits, take all available deductions, and ultimately file your taxes correctly. Some best practices are to:
- Keep separate personal and business bank accounts, so your business income and expenses are clear.
- Track all expenses as you incur them, and also any deductions such as mileage.
- Set aside a portion of earrings for self-employment tax and income tax.
- Work with an accountant who’s familiar with sole proprietor taxes in your state.
If you have a very small sole proprietor business, you might use a bookkeeper rather than an accountant until you grow. As you grow, your tax strategies become more important. You’ll hopefully eventually grow to need an accountant, at which time you might also want to become an LLC or S Corporation.
Is LLC or sole proprietor better for taxes?
An LLC offers an alternative taxation option, which can further reduce some businesses’ taxes. LLCs also come with additional requirements and filings, though. Whether the tax benefits justify the added complexity depends mostly on how profitable your business is.
Default tax treatment
The default tax treatment for LLCs is the same as how sole proprietorships are taxed. Unless the alternative option is selected, a single-member LLC is treated as a pass-through entity. Self-employment tax, income tax, filing a Schedule C and deductions all largely remain the same.
Optional tax treatment
LLC owners have the option to instead be taxed like an S Corporation. This is a more complex method that generally calls for an accountant’s expertise. Broadly speaking, the LLC is taxed as a business, and then the owner(s) can take salaries which are taxed as income. The owners may also receive other payments that get taxed as non-salary income (e.g. distributions).
This option only applies if explicitly selected, and should only be selected after talking with a qualified tax professional.
Liability vs tax difference
An LLC also offers liability protection if the business is sued. The business structure creates a “corporate veil,” which protects personal assets. Most liability lawsuits against the business can’t go after your individual assets.
A sole proprietorship doesn’t offer any such liability protection. If you’re a sole proprietor and successfully sued, your personal assets might be jeopardized.
The liability protection is different from tax structures, and some business owners set up an LLC solely for its corporate veil. (Taxes owed are occasionally referred to as “tax liability,” but this isn’t the same type as a liability lawsuit.)
When LLC may offer tax advantages
An LLC only offers tax advantages when the S-Corp tax structure is selected. Whether the tax savings are greater than the added costs and complexity depends on how much the business earns.
There’s no specific magic number at which all businesses should become LLCs and use the S-Corp tax structure. As a business grows, however, there comes a point at which the switch makes financial sense.
Cost and administrative differences
Sole proprietorships are easy to register and have minimal startup costs. You may need to do virtually nothing, or to file a business name and pay a nominal general license fee.
LLCs come with state filing fees, and can have annual reporting requirements and franchise fees. Exact fees vary by state, but an LLC is virtually always more expensive to start than becoming a sole proprietor.
Again, whether the savings outweigh the extra costs depends on what net profits are.
When to reconsider sole proprietorship status
Many successful entrepreneurs begin as sole proprietors, but eventually change sole proprietorship to LLC structure. They appreciate both the potential tax benefits and the added liability protection. There are a few common times when you might consider becoming an LLC:
- Substantial increase in net profits
- Hiring one or more employees
- Increasing liability exposure
- Seeking outside investment
- Needing stronger personal asset protection
Learn more about what forming an LLC involves, or get help doing so with Tailor Brands’ LLC formation service.
Conclusion
If you’re a sole proprietor, make sure you’re familiar with self-employment tax, tax filing deadlines, and the other relevant details. You may also want to consider switching to an LLC now or in the future, if your business keeps growing.