As a sole proprietor, you are personally liable for all of your business expenses and debts. If someone is hurt on your property, or is harmed by a product that your business made or a mistake of yours, then you are personally liable.
You and your business are seen as one-in-the-same entity. This means that a vendor, customer or financial institution can assess your personal assets for any obligations or debts of the business.
Schedule a no-obligation consultation with a small-business tax expert from 1-800Accountant.
A sole proprietorship is not considered a “formal” company that is independent of its owner.
As such, a sole proprietorship cannot take out a business loan. All business debt is considered personal debt, personally guaranteed by the owner. Again, this means that the lender can go after your personal assets.
Self-Employment Tax
However, the largest & most direct cost that a sole proprietorship will incur is the self-employment (SE) tax.
This tax is assessed at 15.3% on the net profit of the business. It represents the tax paid to the government for Social Security & Medicare funds.
This tax is calculated on IRS Schedule SE and is included with your personal tax return Form 1040.
There is a slight discount when calculating the actual tax due, and you will get a deduction from your income for ½ of the calculated tax, but it still costs you money.
You have to pay this self-employment tax is in addition to your federal and state income tax on your personal tax return.
Calculating Self-Employment Tax
Let’s run through an example of calculating self-employment tax, using the 2019 tax year.
To keep it simple, we’ll presume a taxpayer only has business income, with a filing status of Single, no dependents, and taking the standard deduction:
- The sole proprietorship business shows a net profit for the year of $100,000
- The SE tax calculation starts with the discount, multiplied by the 15.3% tax:
- $100,000 * 92.35% discount = $92,350
- $92,350 * 15.3% tax rate = $14,130 SE tax
(that’s a large chunk to pay in tax!)
- Taxpayer deducts ½ SE tax against income:
- $100,000 – ($14,130/2) = $92,935 adjusted gross income
- Taking standard deduction and qualified business income deduction:
- $92,935 – $12,000 – $20,000 = $60,935 taxable income
- Calculate tax:
- SE tax = $14,130
- Federal tax = $9,346 TOTAL TAX = $23,476
The SE tax is 60% of the Total Tax!
To cut down on the amount of SE tax you’re paying, you may want to consider making your business an S corporation.
