When creating a new business, managers must choose a legal structure for the business that determines how the business pays taxes on income and how owners interact with the business. A sole proprietorship is a business that has a single owner who controls all aspects of the business, which is a common legal structure for new small businesses. Owners of sole proprietorship are not subject to "double taxation."
What Is Double Taxation?
Double taxation is a term that describes money that is taxed twice by the same type of tax. Double taxation usually refers to the income taxes imposed on corporate earnings and dividends. Corporations are considered legal entities separate from the shareholders that own them. Corporations pay income taxes on their profits, and shareholders must also pay income taxes on payments that corporations choose distribute in the form of dividends. This means that the money shareholders receive as cash dividends is subject to income taxes twice: once when the corporations pay taxes on profits and once when shareholders pay taxes on dividends. Sole proprietorships are not considered tax entities separate from their owners, so owners do not face double taxation.
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Sole Proprietorship Income Taxes
The income earned by a sole proprietorship passes directly to the personal income tax return of the owner. If a small business owner makes $100,000 in profit from running his company, he includes that $100,000 as business income on his own income tax return. This means that profit is only subject to income taxation once.
Self-Employment Taxes
While the owners of sole proprietorships are not subject to double taxation, they are considered self-employed workers and are subject to self-employment taxes. The IRS says that self-employment taxes include a tax of 10.4 percent that goes toward Social Security and a tax of 2.9 percent that goes toward Medicare. The 10.4 percent tax that goes toward Social Security only apples to the first $106,800 of income earned.
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Considerations
Sole proprietors must generally make estimated tax payments on a quarterly basis to pay their self-employment taxes and income taxes. Traditional employees don't have to make estimated tax payments because employers withhold money from their income and send it to the IRS on their behalf. If a sole proprietor fails to make estimated tax payments, he may be subject to tax penalties.
