As a sole proprietor, there are several important rules that you
should be aware of:
(1) For income tax
purposes, you'll 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'll 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 an office-at-home, you may be able to deduct commuting expenses of going
from your home to another work location.
(3) You'll be required to
pay self-employment taxes. For 2017, you'll pay self-employment tax (social
security and Medicare) at a 15.3% rate on your net earnings from self-employment
of up to $127,200, 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'll 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'll be required to
make quarterly estimated tax payments. Self-employed individuals are
required to pay their income taxes in quarterly using the estimated tax payment
guidelines, in order to avoid an underpayment penalty.
(6) You'll 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're subject to special recordkeeping requirements
or limitations on deductibility.
(7) If you hire any
employees, you'll 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.
If you’d like any additional information regarding the tax
aspects of your business, or if you need assistance in satisfying any of the
reporting or recordkeeping requirements, please contact us.
