The first thing to know about being a sole proprietor is that a sole proprietorship is a specific type of business structure where the individual and the business are seen as the same entity.
Is your startup a sole proprietorship?
If you haven’t filed any paperwork formally incorporating your business and you are the only person in charge of all business decisions, you are a sole proprietor.
There’s no official process for declaring yourself a sole proprietorship. It’s sort of an “I think, therefore I am” business structure.
If your startup is unincorporated and has more than one founder contributing financial and intellectual capital, you might be considered a partnership. (As taxes for partnerships are a separate topic all on their own, this post will focus only on sole proprietorships).
How does being a sole proprietorship affect my business and income taxes?
In terms of income taxes, sole proprietors file their “business” taxes along with their personal income taxes every April.
What this means is that sole proprietors complete a Schedule C in addition to their personal 1040 tax form. Basically, the Schedule C functions as a handy little worksheet for documenting your business income and expenses.
How does filing a Schedule C affect my business tax deductions?
While personal tax credits, like claiming a child as a dependant, are documented on a personal income tax form, a Schedule C is where a sole proprietor can claim any relevant small business tax deductions.
Some of the most common tax deductions for startups that are sole proprietorships include:
- Startup costs associated with the first year of starting a business
- Depreciation of capital purchases, like software, hardware or manufacturing equipment
- Office expenses from either a formal or home office
- Travel expenses ranging from airfare to meals
- Business mileage on personal vehicles
Keep in mind that sole proprietor tax returns are audited nearly two times more often than those for individual taxpayers. This means when claiming your sole proprietorship deductions, make sure each expense passes the test of being directly associated with the cost of doing business, and keep meticulous records.
Which other taxes should sole proprietors know about?
Two types of federal taxes that sole proprietors should be aware of are employment and self-employment taxes.
If you have employees, you are responsible for withholding income tax and the employee’s 50 percent share of Social Security and Medicare, as well as contributing the employer’s 50 percent share of Social Security and Medicare and 100 percent of the unemployment taxes. Collectively, these taxes are known as employment taxes, which you’ll also commonly hear called payroll taxes.
If you’re flying solo as a sole proprietor with just you and no other employees, you’ll pay self-employment taxes. Because it’s you and only you, you contribute 100 percent of your Social Security and Medicare taxes and there are no unemployment tax contributions.
If you have employees, you can also elect to pay yourself a salary, which puts you back to managing your self-employment taxes as payroll taxes.
Payroll and self-employment taxes are paid on a quarterly basis
Both payroll taxes and self-employment taxes are reported and paid on a quarterly basis. In most cases, the due dates are January 15, April 15, June 15 and September 15, or the following business day if the exact date falls on a weekend or holiday. (Note that the dates may change if you have a fiscal year that’s different from the calendar year).
As self-employment taxes are based on your business income, if it’s your first year of business, you’ll have to estimate what you expect to make in the coming year. After the first year, the previous fiscal year is used as a lookback period for quarterly taxes.
There are still more taxes you need to know
You should also be aware that there are often state and local level payroll and self-employment taxes. Certain businesses may be subject to excise taxes (sin taxes) and sales taxes are controlled at a state level.
As you can see, it gets pretty complicated quite quickly, even you’re a solopreneur.
Perhaps this is why in a survey of 394 small businesses, 71 percent said that their accountant was the most important professional that they worked with.
There’s a little bit of a silver lining for payroll taxes
If you’re a sole proprietor with employees, the employer contributions to payroll taxes are deductible on your business income taxes. The exception being if you pay yourself as an employee, the amounts you contribute to your payroll taxes are still considered self-employment taxes, and therefore are not tax deductible.
If your startup is involved in research and development, you might qualify for the R&D tax credit that lets you write off up to $250,000 in payroll taxes for employees working on qualified research activities.
In order to qualify, you must have annual gross receipts of less than $5 million, be a new startup with less than five years of reporting gross receipts or work in a space that involves qualified activities, like science and technology.
The impact of the new Trump Tax laws on sole proprietorship taxes
With the passing of the Tax Cuts and Jobs Act (TCJA) in late 2017, some sole proprietors may be able to claim a 20 percent tax deduction on their business income when filing taxes for 2018.
This pass-through deduction known as Internal Revenue Code Section 199A (IRC Sec. 199A) is tiered by income and filing status (married or single). There are also exceptions if the business is classified a service industry where the primary assets are based on the skill of the owner. Think doctors, lawyers, etc. However, if your startup has a consulting bend, this may apply to you.
Where to learn more about taxes as a sole proprietor
A first step would be to find an accountant that you feel comfortable with. Then you can find out more by visiting primary sources like the IRS Small Business and Self-Employed Tax Center, Small Business Administration (SBA) and SCORE.
When looking for secondary sources that interpret what the IRS says, be judicial about checking facts and the quality of the writing. Back to step one though, if you’ve got a good accountant, they’ll be able to answer your questions and you won’t have to feel like you need to double check anything.
Disclaimer: This article is intended to be informational and does not replace the expertise of accredited business professionals.