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The 5 Minute Tax Skinny for Every Sole Proprietor

 

The 5 Minute Tax Skinny for Every Sole Proprietor 

BrookWeiner, LLC

 

In this day and age of being able to start a business with just a computer and modem, I have seen many of my good friends and associates fulfill their entrepreneurial dreams by going into business for themselves.

As they take that big first step, working out of their basements or garages (just like Steve Jobs did with Apple), I’m often asked about the tax responsibilities and implications of being a sole proprietor. My response is that rather than a sole proprietorship, generally speaking it's more advantageous from a legal and tax perspectives to either incorporate or establish a limited liability company.

But for those who still prefer to operate their business as a sole proprietorship, following below are some important tax tips to be aware of.

(1) For income tax purposes, you will report your income and expenses on Schedule C of your Form 1040. The net income will be taxable to you regardless of whether you withdraw cash from the business. Your business expenses will be deductible against gross income (i.e., "above the line") and not as itemized deductions. If you have any losses, the losses will generally be deductible against your other income, subject to special rules relating to hobby losses, passive activity losses, and losses in activities in which you weren't "at risk.”

(2) You may be able to deduct office-at-home expenses. If you will be working from an office in your home, performing management or administrative tasks from an office-at-home, or storing product samples or inventory at home, you may be entitled to deduct an allocable portion of certain of the costs of maintaining your home. And if you have a office-at-home, you may be able to deduct commuting expenses of going from your home to another work location.

(3) You will be required to pay self-employment taxes. For 2015, you will pay self-employment tax (social security and Medicare) at a 15.3% rate on your net earnings from self employment of up to $118,500 ($117,000 for 2014), and Medicare tax only at a 2.9% rate on the excess. An additional 0.9% Medicare tax (for a total of 3.8%) will be imposed on self-employment income in excess of $250,000 for joint returns; $125,000 for married taxpayers filing separate returns; and $200,000 in all other cases. Self-employment tax is imposed in addition to income tax, but you can deduct half of your self-employment tax as an adjustment to income.

(4) You will be allowed to deduct 100% of your health insurance costs as a trade or business expense. This means your deduction for medical care insurance won't be subject to the limitation on your medical expense deduction that is based on a percentage of your adjusted gross income.

(5) You will be required to make quarterly estimated tax payments. We can work with you to minimize the amount of your estimated tax payments while avoiding any underpayment penalty.

(6) You will have to keep complete records of your income and expenses. In particular, you should carefully record your expenses in order to claim the full amount of the deductions to which you are entitled. Certain types of expenses, such as automobile, travel, entertainment, meals, and office-at-home expenses, require special attention because they are subject to special recordkeeping requirements or limitations on deductibility.

(7) If you hire any employees, you will have to get a taxpayer identification number and will have to withhold and pay over various payroll taxes.

(8) You should consider establishing a qualified retirement plan. The advantage of a qualified retirement plan is that amounts contributed to the plan are deductible at the time of the contribution, and aren't taken into income until the amounts are withdrawn. Because of the complexities of ordinary qualified retirement plans, you might consider a simplified employee pension (SEP) plan, which requires less paperwork. Another type of plan available to sole proprietors that offers tax advantages with fewer restrictions and administrative requirements than a qualified plan is a "savings incentive match plan for employees," i.e., a SIMPLE plan. If you don't establish a retirement plan, you may still be able to make a contribution to an IRA.

As you start your new business, you’ll have more than enough on your plate in trying to acquire new customers and run your business. Therefore, let us support you in fulfilling your reporting and record keeping requirements. Please feel free to call us at (312) 629-0900.

Disclaimer: The information in this article is general in nature, and is not intended to be nor should it be treated as tax, legal, investment, accounting, or other professional advice. Before making any decision or taking any action, you should consult a qualified professional advisor who has been provided with all pertinent facts relevant to your particular situation.

© 2015 Thomson Reuters/Tax & Accounting. All Rights Reserved.