Being a sole proprietor comes with its own perks and challenges. You get to be your boss, set your own rules, and enjoy the profits of your business. However, with great power comes great responsibility, and as a sole proprietor, you are also responsible for paying taxes on your business’s income. One of the most significant questions that sole proprietors often have is how much they should set aside for taxes. In this article, we will discuss this topic in detail.
Before we dive in, let’s clear one thing up – there is no one-size-fits-all answer to this question. The amount you should set aside for taxes depends on several factors, such as your business’s income, expenses, and tax bracket. However, there are some general guidelines that can help you estimate how much you should set aside for taxes.
Know Your Tax Bracket
The first step in determining how much you should set aside for taxes is to know your tax bracket. As a sole proprietor, your business income is taxed at your individual tax rate. The IRS has seven tax brackets, ranging from 10% to 37%. The tax bracket you fall into depends on your taxable income, which is your business income minus any deductions and exemptions.
Here is a breakdown of the 2021 tax brackets for single filers:
- 10%: up to $9,950
- 12%: $9,951 to $40,525
- 22%: $40,526 to $86,375
- 24%: $86,376 to $164,925
- 32%: $164,926 to $209,425
- 35%: $209,426 to $523,600
- 37%: $523,601 or more
Calculate Your Estimated Taxes
Once you know your tax bracket, you can estimate how much you should set aside for taxes. As a sole proprietor, you are required to pay estimated taxes four times a year – in April, June, September, and January. Your estimated tax payment is based on your taxable income, minus any deductions and exemptions, and your tax bracket.
To calculate your estimated taxes, you can use the IRS Form 1040-ES. The form has a worksheet that can help you estimate your taxes. You will need to know your expected business income, deductions, exemptions, and tax bracket.
Consider Self-Employment Taxes
As a sole proprietor, you are also responsible for paying self-employment taxes, which include Social Security and Medicare taxes. The self-employment tax rate is 15.3% on the first $142,800 of your net income and 2.9% on any income above that amount. However, you can deduct half of your self-employment taxes on your tax return.
When estimating how much you should set aside for taxes, don’t forget to include self-employment taxes. You can use the IRS Form 1040-ES to calculate your estimated self-employment taxes.
Conclusion
As a sole proprietor, it’s important to set aside money for taxes throughout the year to avoid any surprises come tax season. While there is no one-size-fits-all answer to how much you should set aside for taxes, knowing your tax bracket, calculating your estimated taxes, and considering self-employment taxes can help you estimate how much you need to set aside. It’s always a good idea to consult with a tax professional to ensure you are paying the right amount of taxes and taking advantage of any deductions and credits you are eligible for.