Many small businesses begin as sole proprietorships because this business structure is relatively simple and inexpensive to establish and operate. Unlike corporations, sole proprietors generally have direct access to their business profits without needing to make formal distributions.
However, being self-employed also means dealing with tax rules that don’t apply to typical W-2 employees. From reporting business income and claiming deductions to paying self-employment taxes and making estimated payments, there are several important federal tax issues sole proprietors should understand.
Here are some key tax considerations for sole proprietors in 2026.
REPORTING BUSINESS INCOME AND EXPENSES
Sole proprietors generally report their business income and expenses on Schedule C, which is filed with their individual federal income tax return (Form 1040).
Your net business income is generally taxable to you whether or not you withdraw money from the business. Business expenses are generally deducted from business income rather than claimed as itemized deductions.
If your business operates at a loss, you may generally be able to use that loss to offset other income. However, several special rules can limit your ability to deduct business losses. These include rules involving hobby losses, excess business losses for noncorporate taxpayers, passive activities and activities in which you aren’t considered financially “at risk.”
SPECIAL DEDUCTIONS FOR SOLE PROPRIETORS
Self-employed individuals may qualify for certain tax deductions that aren’t generally available to employees.
For example, you may be eligible for an above-the-line deduction for qualifying self-employed health insurance premiums. This can include premiums for medical, dental and qualifying long-term care coverage, subject to applicable limitations.
Because this deduction is taken as an adjustment to income, it isn’t subject to the same limitations that apply when medical expenses are claimed as an itemized deduction.
HOME OFFICE DEDUCTION
You may also qualify for a home office deduction if you regularly and exclusively use part of your home for business and meet certain requirements.
Generally, you may qualify if:
- Your home office is your principal place of business, including when you use it for management or administrative activities and have no other fixed location where you perform those duties.
- You regularly use your home to meet with customers, clients or patients as part of your business.
- You use your home to store inventory or product samples.
If you qualify, the deduction may include an appropriate portion of expenses such as mortgage interest or rent, insurance, utilities, repairs, maintenance and, for homeowners, depreciation.
You may also choose a simplified home office deduction based on the square footage of the qualifying business space. Depending on your circumstances, certain travel expenses between your home office and another business location may also be deductible.
KEEP DETAILED BUSINESS RECORDS
Good recordkeeping is essential for maximizing legitimate tax deductions and supporting the amounts reported on your tax return.
Pay particular attention to expenses such as automobiles, travel, meals and home office costs. These expenses may be subject to special documentation requirements, deduction limits or other tax rules.
Keeping organized records throughout the year can make tax preparation easier and help ensure you don’t overlook deductions.
CLAIMING THE QUALIFIED BUSINESS INCOME DEDUCTION
Another potentially valuable tax break for sole proprietors is the Section 199A qualified business income (QBI) deduction.
Generally, the deduction can equal up to 20% of qualified business income, although additional limitations may apply. QBI generally consists of the net amount of qualified income, gains, deductions and losses that are effectively connected with the conduct of a U.S. trade or business.
Certain investment-related items and reasonable compensation paid to an owner for services provided to the business generally aren’t included in QBI.
The QBI deduction is taken below the line. In other words, it reduces taxable income rather than gross income. You can generally claim the deduction even if you take the standard deduction instead of itemizing.
QBI DEDUCTION LIMITS FOR 2026
Higher-income taxpayers may face additional limitations on the QBI deduction.
For 2026, these limitations generally begin to apply when taxable income, calculated before the QBI deduction, exceeds:
- $201,750 for most taxpayers
- $403,500 for married couples filing jointly
For 2026, the limitations are generally fully phased in once taxable income exceeds:
- $276,750 for most taxpayers
- $553,500 for married couples filing jointly
The exact limitations that apply can depend on your income and the nature of your business.
The One Big Beautiful Bill Act (OBBBA) also made the QBI deduction permanent. Beginning in 2026, the law expands the income ranges over which certain QBI limitations phase in, which could allow some taxpayers to receive larger deductions.
The legislation also created a new minimum QBI deduction of $400 for taxpayers who materially participate in an active trade or business and receive at least $1,000 of QBI from that business. Beginning after 2026, the $400 minimum deduction will be adjusted annually for inflation.
UNDERSTANDING SELF-EMPLOYMENT TAX
One of the major tax differences between being an employee and running your own business is self-employment tax.
Self-employment taxes generally cover Social Security and Medicare taxes. Employees typically share these payroll taxes with their employers, but self-employed individuals generally pay both the employer and employee portions.
Self-employment tax is imposed in addition to federal income tax. However, you can generally deduct one-half of your self-employment tax as an adjustment to income.
For 2026, the self-employment tax rate is 15.3% on net self-employment earnings up to $184,500. This consists of Social Security and Medicare taxes. Net earnings above that amount are generally subject to the 2.9% Medicare tax.
An additional 0.9% Medicare tax may apply to self-employment income above:
- $250,000 for married couples filing jointly
- $125,000 for married taxpayers filing separately
- $200,000 for other taxpayers
The thresholds for the additional Medicare tax aren’t adjusted for inflation.
CONSIDER A TAX-ADVANTAGED RETIREMENT PLAN
A retirement plan can be another valuable tax-planning tool for a sole proprietor.
Contributions to a qualified retirement plan may generally be deductible when made, while the amounts contributed and investment earnings generally aren’t subject to income tax until they’re withdrawn.
One option is a Simplified Employee Pension (SEP) plan. SEPs generally require relatively little paperwork and can allow substantial contributions.
In many cases, you can establish a SEP and make deductible contributions for a tax year as late as the due date of your income tax return, including extensions.
Contribution amounts are generally discretionary, but if you have eligible employees, they generally must be included in the plan and receive contributions under applicable rules.
If you don’t establish a qualified retirement plan, you may still be able to contribute to a traditional IRA. However, the annual contribution limits are generally much lower.
MAKE QUARTERLY ESTIMATED TAX PAYMENTS
The federal tax system generally operates on a “pay-as-you-go” basis. Because sole proprietors typically don’t have taxes withheld from their business income, they may need to make estimated tax payments throughout the year.
Estimated payments generally need to cover both federal income taxes and self-employment taxes. Taxpayers commonly use Form 1040-ES to calculate their estimated payments.
The standard quarterly due dates are generally:
- April 15
- June 15
- September 15
- January 15 of the following year
If a payment deadline falls on a weekend or legal holiday, the due date generally moves to the next business day.
Making sufficient payments by the required deadlines is important. Underpaying estimated taxes can result in interest and penalties.
WHEN DOES A SOLE PROPRIETOR NEED AN EIN?
A sole proprietor doesn’t automatically need an employer identification number (EIN). In many situations, you can use your Social Security number for federal tax purposes.
However, an EIN is generally required if you hire employees. You may also need one if your business:
- Owes employment or excise taxes
- Withholds certain taxes on payments to a nonresident alien
- Establishes certain retirement plans
- Changes its legal structure, such as incorporating or forming a partnership
Even when an EIN isn’t required, you may choose to obtain one for banking or administrative purposes.
The IRS provides EINs at no charge through its website. When applying, you’ll generally need identifying information, including a valid Social Security number or another taxpayer identification number, along with information about your business.
Eligible U.S. applicants can generally receive an EIN immediately after completing the online application. Form SS-4 can also be submitted by fax or mail.
WE CAN HELP WITH YOUR BUSINESS TAXES
Running a small business doesn’t mean your tax obligations are simple. Sole proprietors need to consider income reporting, business deductions, self-employment taxes, estimated payments, retirement planning and other federal tax requirements.
The issues discussed here are only some of the federal income tax rules that may apply to sole proprietors. Depending on where your business operates, you may also have state and local income, sales, payroll and other tax obligations.
If you have questions about your business tax responsibilities, deductions, recordkeeping or tax planning, contact us. We can help you understand the rules and identify opportunities to manage your tax obligations more effectively.
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