Tax Implications for a Sole Proprietorship

Running a business by yourself is a daunting task. One of the biggest concerns for some people is understanding the requirements for tracking and paying taxes. For the sole proprietor, there are at least five main issues to keep your business taxes in compliance with the IRS.

Hobby vs. Business

• The first key determining factor in the reporting of your sole proprietorship to the IRS is to make sure your business is considered a business versus being labeled as a hobby. Expenses for a business may be deducted from income before paying taxes. Hobby expenses may not be deducted.

  In general, your activities will be considered a business if is profitable in three of the last five tax years. See IRS fact sheet 2008-23 for more help in determining if you qualify to deduct business expenses.

Income Tax

• The profit or loss from your sole proprietorship business is reported annually with your personal income using the IRS Schedule C form with your 1040 tax return. Businesses with less than $5,000 in expenses may be able to use the simpler Schedule C-EZ form.

Self-Employment Tax

• Self-employment taxes are the portion of income paid to support Social Security and Medicare programs. Currently, if your net earnings are more than $400, you are required to pay self-employment taxes. This is done by including Schedule SE with your personal 1040 tax return.

Estimated Tax

• The IRS method of tax collection is known as a pay-as-you-go system. For employees this is accomplished by withholding taxes from each paycheck. However, as a sole proprietorship, you may not elect to receive a regular paycheck from your business. In this case, you must make estimated tax payments if you expect to owe more than $1,000 in taxes at the end of the year.

  Estimated tax payments are due in April, June, September and January. See the most recent version of IRS form 1040-ES for more specific information.

Tax Withholding

• As mentioned above, if you employ others to work for your business, you must withhold Social Security and Medicare payments from employee paychecks and file reports both quarterly and annually. This is normally done through a payroll system or third-party service.

Contacting the IRS

• To discuss your specific questions, you can call the IRS Business and Specialty Tax Line toll free at 1-800-829-4933.