Operating as a sole trader—also known as a sole proprietor in the U.S.—is one of the simplest and most common ways to start a business. Whether you’re a freelancer, independent contractor, small business owner, or side hustler, working as a sole trader means that you and your business are legally one and the same. While this structure offers simplicity, it also brings personal responsibility, especially when it comes to paying taxes.
Understanding how to manage your taxes is essential to avoiding surprises from the IRS, staying compliant with regulations, and building a financially healthy business. This guide breaks down how tax works for sole traders in the U.S., including income tax, self-employment tax, estimated tax payments, deductions, and filing requirements—all explained in detailed paragraphs for clarity.
What It Means to Be a Sole Trader for Tax Purposes
As a sole trader, your business earnings are reported as part of your personal income. You do not file a separate tax return for your business. Instead, you report your business income and expenses using Schedule C (Profit or Loss from Business), which is submitted along with your individual Form 1040. There’s no need to form a legal entity such as an LLC or corporation to start, but that also means you’re personally liable for the business’s tax obligations and debts.
This pass-through taxation structure means your business profits are taxed once, at your personal income tax rate. However, that also makes you responsible for handling everything, from tracking income and expenses to filing your return and making sure your tax payments are made on time.
Federal Income Tax for Sole Traders
All net income you earn through your sole proprietorship is subject to federal income tax. The term “net income” means your total revenue minus your deductible business expenses. You calculate this figure on your Schedule C and then transfer the resulting profit or loss to your Form 1040.
Your tax rate depends on your total taxable income from all sources and falls within the graduated income tax brackets. The more you earn, the higher your rate. It’s important to note that business losses can be used to offset other types of income, potentially reducing your total taxable income.
Since there’s no employer withholding taxes on your behalf, it’s your job to plan accordingly throughout the year. Many sole traders are surprised by how much they owe at tax time because they didn’t factor in the appropriate tax percentage from each payment received.
Self-Employment Tax Explained
In addition to income tax, sole traders must also pay self-employment tax, which covers your contributions to Social Security and Medicare. This is in place of the payroll taxes typically split between an employer and employee.
In 2025, the self-employment tax rate remains at 15.3%, which includes 12.4% for Social Security and 2.9% for Medicare. If your net earnings exceed $200,000 (for individuals) or $250,000 (for married couples filing jointly), an additional 0.9% Medicare surtax applies.
To calculate this, you’ll complete Schedule SE (Self-Employment Tax) and attach it to your Form 1040. The IRS allows you to deduct half of your self-employment tax (i.e., the “employer” portion) as an adjustment to income, which helps slightly reduce your overall tax burden.
Do Sole Traders Need to Pay Quarterly Taxes?
Yes, in most cases. Since taxes aren’t withheld from your income automatically, the IRS expects you to make estimated tax payments on a quarterly basis. If you expect to owe $1,000 or more in taxes for the year, you’re generally required to make these payments.
Estimated taxes cover both your income tax and self-employment tax, and the due dates for 2025 are as follows:
● April 15, 2025 (for Q1 income)
● June 17, 2025 (for Q2 income)
● September 16, 2025 (for Q3 income)
● January 15, 2026 (for Q4 income)
Missing these deadlines or underpaying your taxes throughout the year can lead to penalties and interest. Many sole traders choose to set aside about 25–30% of their income for taxes and use that reserve to pay quarterly.
Deductible Business Expenses and Why They Matter
One of the biggest tax advantages for sole traders is the ability to deduct ordinary and necessary business expenses. These deductions reduce your net income and, in turn, the amount of tax you owe.
Common deductions include home office expenses, internet and phone costs, supplies, business software, vehicle mileage (for business use), travel, marketing, professional development, insurance, and meals (when incurred for business purposes). If you use part of your home exclusively for business, you may qualify for the home office deduction, which can be calculated using either the simplified or actual expense method.
Maintaining detailed records is crucial. Save receipts, track mileage logs, and keep a separate bank account for business transactions. Not only does this make filing taxes easier, but it also ensures you’re prepared in case the IRS requests documentation during an audit.
State and Local Tax Obligations
In addition to federal taxes, most states impose their own income tax, and sole traders are responsible for complying with those requirements too. The rules vary widely by state. Some states, like Florida and Texas, do not charge personal income tax at all, while others, like California and New York, have complex tax codes and higher rates.
You may also be responsible for local business taxes, permits, or sales tax if you sell taxable products. It’s important to check with your state department of revenue and local municipality to understand what registrations or filings are required for your specific location and industry.
Neglecting to comply with state and local rules can result in unexpected penalties, back taxes, or even business restrictions. Be proactive about understanding your full tax landscape.
How to File Taxes as a Sole Trader
Filing taxes as a sole trader typically follows this workflow: You gather all your income and expense records for the year, fill out your Schedule C to calculate your business’s net profit, complete Schedule SE to determine your self-employment tax, and then report everything on your Form 1040. If you made estimated payments throughout the year, those will be credited to your tax balance.
You can file your return yourself using tax software like TurboTax, H&R Block, or TaxSlayer, which offer versions designed for the self-employed. Alternatively, many sole traders work with a CPA or enrolled agent—especially as their business income grows more complex.
Even if you’re confident filing on your own, having a tax professional review your first return as a sole trader can help you uncover missed deductions and avoid costly mistakes.
Conclusion
Being a sole trader offers flexibility and independence, but it also comes with the full responsibility of managing your own tax obligations. Unlike traditional employment, taxes aren’t taken out of your income automatically, so it’s essential to stay proactive—tracking income, saving for taxes, making quarterly payments, and maintaining organized records. Understanding how to properly report your income, calculate and pay self-employment taxes, and claim all relevant deductions is critical to staying compliant and making your business financially sustainable.
With careful planning, proper tools, and possibly some expert help, paying taxes as a sole trader doesn’t have to be overwhelming. It can become a manageable—and even empowering—part of running your business successfully. The key is to stay informed, stay organized, and treat your tax duties as an essential part of your business strategy.
FAQs
Do I need to register my sole proprietorship with the IRS?
No. You don’t need to register with the IRS specifically as a sole proprietor. However, if you plan to hire employees or open a business bank account, you may need an Employer Identification Number (EIN).
How much should I save from each payment for taxes?
It’s a good idea to save around 25–30% of each payment to cover both federal and state taxes, including self-employment tax. The exact percentage depends on your location and income level.
Can I switch from sole trader to LLC later?
Yes, many business owners start as sole traders and later form an LLC to gain liability protection and potentially alter how their income is taxed. It’s a flexible transition that can happen as your business grows.
What happens if I don’t pay estimated taxes?
If you fail to make required estimated tax payments throughout the year, you may be subject to IRS penalties and interest. Even if you pay in full at the end of the year, the IRS expects you to pay as you earn.
Do I need a separate bank account for my sole proprietorship?
While it’s not required by law, it is highly recommended. Separating your personal and business finances makes tax time easier and provides a clearer picture of your business’s performance.
