Sole proprietors are pass through businesses that are taxed a flat rate of
15.3% (Social Security and Medicare) by the U.S. Internal Revenue Service for business income up to $106,800, and half the tax is deductible from regular income. Sole proprietors are individuals who work as contractors, sub-contractors and otherwise provide a product and/or service as a company that is not a partnership, limited liability corporation, small business or corporation.
Sole proprietorships are directly liable for business expenses and legal actions taken against the sole proprietors. Sole proprietors do not have to be incorporated and may or may not have employer identification numbers. In such cases, social security numbers are required for tax identification.
Specific tax implications exist for sole proprietors that do not necessarily exist for regular income earners. For example sole proprietors are subject to self-employment tax, and additional tax reporting requirements such as employer filings and business income and expense reporting. These additional responsibilities necessitate the use of additional tax forms to be filed alongside an Internal Revenue Service form 1040. Despite the necessity for additional tax forms, the financial benefits for filing taxes as a sole proprietor may be advantageous and worth the time it takes to fill out the extra forms.
Sole proprietor tax forms and their implications
A sole proprietor can file with a regular 1040 and a
Schedule C or
C-EZ. The income or loss that is incurred through the sole proprietorship is then reported on form 1040 as business income or loss. Typically a schedule C includes information such as the nature of business, employer identification number if any, address, income, expenses, vehicle expensing etc. Part II of Schedule C includes 23 expenses from lines 8-27 including 16,20, and 24 b. Examples of these expenses are advertising, employee benefits, office expenses and utilities. Business expenses incurred through a sole proprietorship can lower taxable income for the sole proprietor.
Sole proprietors are subject to self-employment tax of approximately 15.3% which is reported on the form 1040
Schedule SE. Half of the self-employment tax is deductible from regular income in the adjustments section of the form 1040. Self-employment tax is not reduced by standard or itemized deductions.
If a sole proprietorship has employees, form W2's should be submitted to the IRS and the employees indicating income and withholdings for the employees. A sole proprietor may also have income from other sources of income outside the business that should be filed along with the 1040 as regular income. Such income may include capital gains, interest income and wages from regular employment.
Sole proprietor tax tips
When filing taxes as a sole proprietor it can be a good idea to be aware of as much as the tax rules and regulations as possible. When in doubt contacting a tax professional, Government tax specialist or tax help guides may be beneficial in gathering the appropriate information, minimizing tax paid and accurately filing taxes. A few tips about filing taxes as a sole proprietor are below, however these tips do not replace the advice of a tax professional.
• Gross Income: If gross income is below the minimum required for filing taxes with the IRS, a sole proprietor still has to file a tax return with the IRS if the business income is more than $400.00.
• Amendments: If self-filing and errors are realized on tax forms following submission of the original tax filing and amendment may be filed. An amendment can be sent to the IRS using a form 1040X.
• State Taxation: Taxation of sole proprietorships may vary from state to state. Some states may require separate reporting and/or taxation for income earned through a sole-proprietorship.
• Home office deductions: Making use of a designated home office may lower taxable business income through higher expenses. Paying bills during the tax year and keeping records of such bills can assist in recording and reporting of such expenses. An IRS form 8829 can be used to deduct such expenses.
• Non-Home office Expenses: If a sole proprietorship does not qualify for home office deductions, legitimate office expenses and supplies can be reported and deducted from total income on a schedule C.
• State and Federal Contacts: Contacting federal and state tax authorities with tax questions may be more cost effective than hiring a tax accountant or tax preparation professional.
Summary
Sole proprietorships are self managed businesses that are not classified as other types of businesses. Sole proprietors are directly responsible for actions, consequences and taxation of income earned through the proprietorship. Tax filing for a sole proprietorship makes use of a few additional forms but is less complicated than larger businesses in terms of tax reporting. Self-employment tax is a responsibility of sole proprietors and can add up to approximately 15.3% of total business income which cannot be reduced through standard deductions.
There are advantages and disadvantages to sole-proprietorships. An advantage is the income earned through such a business can be reduced through legitimate expensing such as home office deductions that are reported on IRS form 8829 and then transferred onto a schedule C and then onto a schedule SE in the case of home office deductions. Otherwise, expenses can be reported directly onto a schedule C. The tax rate for sole proprietorships is lower than the normal income tax rate for income between $30,650- $97,500. That is to say self-employment tax is a flat rate up to $97,500. Consequently, there are recognizable tax benefits of earning income through a sole-proprietorship.
Sources:
1. http://www.irs.gov (U.S. Internal Revenue Service)
2. http://www.ebtax.com/income/sole_proprietorships.htm
3. http://www.sbinformation.about.com/cs/accounting/a/aa121502a.htm
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