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The taxation difference between sole proprietors and employees comes down to self employment tax which is 15.3%. Self employment tax has historically had a negative connotation, but when the facts of self employment tax are understood, it's not the "monster" it appears to be. In fact, sole proprietors will sometimes pay less in taxes than employees.

Sole Proprietors

A sole proprietor is a person who is self employed (not partnered or incorporated). The IRS has guidelines defining the sole proprietor, such as, if the taxpayer is providing their own equipment, they could be a sole proprietor. Those receiving 1099s or tracking their own income and expenses should be sole proprietors. Regarding personal exemptions and standard deductions (not to be confused with income and expenses) for short form filers, there is no difference between sole proprietorship and employees. Regarding itemized deductions for long forms filers there could be slight differences. Some qualifying deductions as a sole proprietor could be considered business deductions rather than personal deductions.

Self Employment Tax

Self employment tax, simply put, is Social Security and Medicare Tax, and all taxpayers pay it. There are two main differences between paying the taxes as a sole proprietor instead of an employee. First, as an employee, the employee is paying half of the 15.3% tax and the employer is paying the other half of the tax where the sole proprietor is paying the full 15.3%. The second difference is employees have their taxes withheld from paychecks throughout the year, and a sole proprietor pays the tax either by installments, such as quarterly taxes, or when taxes are reconciled at the end of each tax year, or other method they have set up with the IRS. The final amount of self employment tax each year is determined on form SE, and the maximum income for each individual subject to tax is $97,500.00

As a sole proprietor, gross receipts (fancy name for income) are stated on Schedule C, all qualified expenses from business are deducted on Schedule C, and the net income is then reported on form 1040 line 12. Self Employment Tax is calculated, and half this amount is entered on form 1040 line 27 to adjust the income before calculating federal tax. Because of business deductions, sole proprietors can actually pay less in overall taxes than employees.

How Sole Proprietors can Benefit on Their Taxes

The best way to look at how self employment tax can actually benefit sole proprietorship is to

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