Contractor License Practice Exam

In a sole proprietorship, how is the owner taxed?

1. At corporate tax rates

2. At a flat tax rate

3. At the owner's individual tax rate

4. No taxes are paid

The correct answer is: At the owner's individual tax rate

In a sole proprietorship, the owner is taxed at their individual tax rate. This means that the income generated by the business is reported on the owner’s personal tax return. Sole proprietors do not pay corporate taxes; instead, the business profits are passed through directly to the owner, who includes that income on their personal tax return. This structure is beneficial for many small business owners as it allows them to avoid the double taxation commonly associated with corporations, where both the business and the individual owners may be taxed separately. Consequently, the tax obligations align with the owner’s income level, which can potentially result in a lower effective tax rate if the owner has lower overall income.