What Taxes Do Sole-Proprietors Pay?

Late last month, golfer Phil Mickelson created some controversy when he was talking about moving out of his home state of California because of the tax burden he faced.  As he was talking with the press, he said the following:

“If you add up all the federal and you look at the disability and the unemployment and the Social Security and the state, my tax rate’s 62, 63 percent. So I’ve got to make some decisions on what I’m going to do.”

There has been quite a bit of discussion about what he said and whether or not he should have said anything, but that isn’t why I brought it up (and I am not trying to be political, either).  Phil Mickelson, like some of you, is a sole-proprietor.  He has to run a business, and report his earning to the IRS as well as the state of California.  So what taxes, as a sole proprietor like Phil Mickelson, do you have to pay?

Let’s start with the IRS.  Since you own a business, you will need to report your earnings on Schedule C when you do your taxes for the year.  The income from this business flows over to your personal income tax form, form 1040, which is combined with your other sources of income to give your taxable income and then your tax liability for the year.

In addition to your personal income taxes, your income from your business is used on federal schedule SE to calculate you self-employment income.  When you work for someone else, you would have Social Security and Medicare contributions withheld from your paycheck.  However, since you don’t get a paycheck as a sole proprietor, your contributions to these programs are calculated when you calculate your self-employment taxes on form SE.  You would owe self-employment taxes if you made more than $400 during the year.  If you made less than $110,100, you would owe 13.3% of your profits, but this percentage will go up to 15.3% after February 29th of this year.  If you made more than $110,100, you would owe $11,450.40 plus 2.9% of the profit you made in your business.  These percentages are higher than what they were when you were an employee.  This is because, as an employee, you only had to pay half of the amount due to the government, with your employer kicking in the other half.  While it may seem like a lot, you will be able to deduct 50% of your self-employment taxes as an adjustment to income on your form 1040 on line 27 of form 1040.

In addition to your federal taxes, you will also have to pay state taxes.  The amount of business income you reported on Schedule C will be used by most states to determine your state tax liability.  In addition, you may be required to pay excise taxes if you have a certain type of business.  Check with your state’s department of revenue to see what type of excise taxes for which you might be liable.

Is all this a lot to take in?  Maybe, but if you run into problems or have additional questions, a good accountant (like the author of this post) would be more than happy to give you a hand.

Are you confused about your small business taxes? Check out Outright’s Tax Resource Center for more information for tax beginners and old pros!

In accordance with Circular 230 Treasury Department Regulations, we are required to advise you that any tax advice contained in this article may not be relied upon to avoid penalties under the Internal Revenue Code.  If you are interested in a written opinion that can be relied upon to prevent the imposition of tax-related penalties, please contact the author.

The author, Chris Peden, CPA, CMA, CFM, has over 15 years of experience with helping people and companies with organizing and making sense of their finance information, as well as meeting their regulatory compliance requirements.  He is also available as a freelance blogger if you need an article on finance, accounting or taxes for your blog.  He can be reached at chrispedencpa@yahoo.com.

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