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Starting a business? Sole proprietorship tax info

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If you are starting a business of your own, congratulations and best wishes! Here are some things you probably want to know, from a tax perspective.

If you simply open the doors and start selling your product or service, the IRS considers you a self-employed sole proprietor. This is also the case if you are an independent contractor who receives Form 1099-MISC with Nonemployee Compensation reported in box 7.

As a sole proprietor, you file Schedule C with your 1040. You report your business income and expenses on Schedule C. Several things to note here:

If you have a Web site, you normally deduct the costs associated with the Web site on line 8, Advertising.

If you pay independent contractors for services related to your business, you deduct those payments on line 11. If you have employees, you deduct their salaries and wages on line 26. Note that you cannot deduct any payments that you make to yourself – you cannot treat yourself as an employee of your own sole proprietorship.

You can choose to deduct either the actual costs of operating a vehicle that you own or lease on line 9, or take the standard mileage rate (55 cents per mile in 2009). Regardless of which method you choose, you must keep written records showing the business use percentage of a personal vehicle, and you can deduct only the portion of your costs based on the percentage of business use.

Depreciation (line 13) can be complicated. Generally, you depreciate any item of equipment that you expect to use in the business for longer than 1 year (based on the percentage of business use). You can elect to expense items under section 179 rather than depreciate, but be aware that if the business use percentage of those items drops below 50%, or if you dispose of the item before the end of the depreciation period, you will have to take the difference between the amount you expensed and the amount that you would have deducted had you depreciated the item, and declare it as income. Thus, use section 179 expensing carefully. I normally suggest that big-ticket items be depreciated rather than expensed; you don’t usually need that much of a deduction when establishing the business and it can really bite you hard if you wind up going out of business before you reach the end of the depreciation period.

On line 17, deduct any fees you pay to attorneys and CPAs, and the portion of your tax preparation fees that are related to the business portion of your return.

On lines 24a and 24b, you deduct travel expenses and expenses for meals and entertainment. You cannot normally deduct meal expenses unless (a) you are traveling and required to stop for substantial sleep or rest in order to perform your duties, or (b) the meal has a business-related purpose, which usually means that it takes place in a clear business setting and is for your business, or that you conducted substantial business during the meal.

If your net earnings from your business, after expenses, exceed $433, you must also file Schedule SE and pay self-employment tax, which is your share of the Social Security and Medicare tax that you normally have withheld on a W-2, plus the share of those taxes that is paid by your employer when you receive wages. SE tax amounts to 15.3% of your net earnings, multiplied by 92.35%. You deduct half of the SE tax on line 27 of your Form 1040.

These rules hold even if you create a Limited Liability Corporation (LLC), if you are the sole member of the LLC; the IRS disregards the LLC and treates you as a sole proprietor under those circumstances.


Written by nctaxpro

March 24, 2010 at 11:41 am

Posted in Small Business, Taxes

3 Responses

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  1. Could you clarify how to determine the date that a sole proprietorship starts? Do I have some latitude there, or is it fixed as, say, the first day I actually take in revenue?

    (My question really boils down to this: can I deduct business expenses from investment income before I take in revenue from the business?)


    Jim Fickett

    April 13, 2010 at 10:44 pm

    • Jim:

      Basically, the start date of any business is the date on which the public can access the products or services that you offer. In a retail business, the start date is the date on which you open the doors. If you are providing a service, the start date is the date on which you start your efforts to acquire clients for your service (either via published advertisements, a Web site, or by whatever means you choose to use).

      I’ve found this book by Eva Rosenberg (AKA TaxMama), Small Business Taxes Made Easy, to be the most useful guide to starting a small business.


      April 15, 2010 at 7:34 am

  2. I wish to start a Franchise of a HR agency under sole proprietorship. Can I do so without any legal registration.


    June 30, 2010 at 11:03 pm

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