What taxes do I owe in my first year in business?

A first-year owner generally faces four layers: income tax on the profit, self-employment tax on net earnings, quarterly estimated payments covering both, and payroll tax if anyone is hired. State and local obligations sit on top and follow their own rules. Profit is taxed when earned, not when withdrawn, which is what surprises owners in year one.

For tax year 2025

15.3% (12.4% Social Security up to the wage base, plus 2.9% Medicare) (self-employment tax rate, 2025)

Key points

A sole proprietor reports business profit on Schedule C, and that profit is taxed on the personal return whether or not the owner withdrew any of it.
Self-employment tax applies to net earnings from the business in addition to income tax, covering both the employee and employer share of Social Security and Medicare.
Someone in business for themselves generally has to pay estimated tax across four payment periods, and estimated tax covers income tax and self-employment tax together.
No estimated tax is required for the current year if the taxpayer had no tax liability in the prior year, was a US citizen or resident alien for that whole year, and the prior year covered twelve months.
Hiring a first employee starts a separate employment tax system with its own deposits, returns, and penalties, and state and local obligations run independently of federal ones.

What is taxed in the first year, and when?

Business profit is. A sole proprietor or single-member LLC reports on Schedule C, which is used for income or loss from a business operated or a profession practised as a sole proprietor. The activity qualifies as a business when the primary purpose for engaging in it is income or profit and the owner is involved with continuity and regularity — a test that matters in a first year, since an activity failing it is treated differently and its losses are restricted.

The timing point catches almost every new owner. Profit is taxed when it is earned, not when it is withdrawn. Money left in the business bank account to fund next year's growth has already been taxed to the owner, which is why a first-year tax bill can arrive when the account looks healthy and no salary was ever taken.

What is self-employment tax and why is it separate?

Self-employment tax is the Social Security and Medicare tax a self-employed person pays on net earnings from the business. A wage earner and their employer each carry half; a self-employed person is both and carries both, which is why it lands harder than people expect.

It runs alongside income tax rather than inside it. An owner whose first year produced modest profit can be in a low income tax bracket and still owe a real amount of self-employment tax, because it is charged on net earnings from the business rather than on income left after a standard deduction, and it starts once net earnings reach a small annual threshold rather than at a bracket. Half of the tax is deductible against income, which softens it slightly.

When do you have to start paying during the year?

Tax is paid as income is earned, either through withholding or through estimated tax payments, and being in business for yourself generally means making estimated payments. The year is divided into four payment periods, each with its own due date, and estimated tax covers income tax and self-employment tax together. Underpaying produces a penalty that can apply even when the return ultimately shows a refund.

First years are awkward because there is no settled prior year to base payments on. One relief helps: no estimated tax is required for the current year if you had no tax liability for the prior year, you were a US citizen or resident alien for the whole of that year, and it covered twelve months. Someone starting out from a year with no tax liability has room; someone who left a well-paid job does not, and should start estimating from the first profitable quarter. Anyone who also holds a job can raise withholding on a new Form W-4 instead of paying separately.

What else starts in year one that people miss?

Hiring is the big one. The first employee opens a separate employment tax system with deposit schedules, periodic returns, and its own penalties, and it begins at the first hire rather than at some later size. Paying contractors instead avoids payroll but not the classification question, which has to be settled before the first payment rather than after it. State and local obligations sit outside the federal picture entirely, they vary by state, and they are not covered by federal guidance — depending on where you operate they can include income, franchise, gross receipts, or sales taxes, each with its own registration and deadlines that a federal payment does nothing about. The state revenue department is the authority on which of them apply to you.

Two first-year decisions are harder to unwind later. To preserve the option of using the standard mileage rate for a car you own, you have to choose that method in the first year the car is available for use in the business; from then on you can move between the standard mileage rate and actual expenses in later years. And substantiation is a legal requirement, not a preference — expenses must be supported by adequate records or sufficient evidence, and a first year reconstructed from memory the following April is where legitimate deductions quietly disappear.