SOLE PROPRIETORSHIP TAXES
Get to know all the deductions you can make toward your Sole Proprietorship Business in New York City
You’ve opened your doors on your very own business. Congrats! You have a world of exciting, yet challenging, times ahead of you.
Before this big moment happens, though, we hope you thoroughly research all your options regarding business entity structure.
Better yet, let your partners at Savvy & Suite do the research, allowing you to invest much-needed time back into that fledgling business.
One option for you to consider would be the sole proprietorship. What is a sole proprietorship, you may ask?
One sole proprietorship definition is a formed entity with a single person (sole proprietor, after all!) that is loosely bound in order to form a business unit. While there are more robust business entity classifications, there are some sole proprietorship advantages.
For starters, this entity structure is the easiest to set up. Often, there is no formal registration process to recognize your business as a sole proprietorship. This is easier than some other types of entities, where you must file with your local authorities, file additional forms with the Internal Revenue Service stating your intention to be taxed a certain way, and create an operating agreement/articles of incorporation to fully form and govern your business.
None of that is needed, which gives you the freedom to run the business how you choose. This ease of startup is so important because a sole proprietorship business may be a simple concept, whether it’s starting a stand at your local Farmer’s Market or picking up extra shifts as a freelance writer.
These businesses are not anything crazy elaborate, so the administrative ease of a sole proprietorship makes it a popular choice for small businesses.
Unfortunately, there are some downsides to this entity classification. The sole proprietorship is often viewed as one with the owners instead of separate from the owners, like other entities.
This is especially important to consider through the lens of liability. Because the sole proprietor is viewed as their business, this implies that their personal assets are also part of the business, opening up the door for liability nightmares.
There isn’t much of a corporate shield in this entity structure, so if you have a low risk tolerance, other options may be better.
How does one account for sole proprietorship taxes? In the eyes of the Internal Revenue Service, your sole proprietorship acts like a flow-through entity without having the additional business compliance filings required of other flow throughs.
This is another area where the sole proprietorship presents a bit more ease relative to other entity classifications. Because there are no additional business filing requirements, your sole proprietorship’s business profits are reported directly on your personal return.
Take, for instance, our Farmer’s Market example. You’ve grown the produce, accumulating expenses along the way. Once you sell your produce at the market, you’ll generate revenue. At the end of the year, those figures will be reported on Schedule C, Profit or Loss from a Business (Sole Proprietorship).
This functions as your tax income statement, determining what amount should be subject to tax if you made a profit in that year (we surely hope so!).
From Schedule C, what happens? The end result, your business taxable income, is included in the grand summing of all your other sources of personal income from the year. After deducting applicable deductions, that sum of income (including your business income, remember) is subject to your individual tax rate.
There’s another hidden tax associated with this amount, though. Sole proprietorships are subject to self-employment taxes. This is a roundabout way of charging sole proprietors a similar type of taxes as one would expect to see on your paycheck.
Although not exactly apples to apples, this is seemingly a good comparison when looking at self-employment taxes. Self-employment taxes are covered by a sole proprietor, accounting for the business’ portion of the taxes and the individual’s portion.
This is where it’s helpful to compare to your paycheck; your employer pays a portion of employment taxes, as do you. Because a sole proprietorship is both a business and an individual, we’re stuck with the full amount of self-employment taxes.
Don’t worry, though; the Code gives sole proprietors the ability to deduct one-half of their self-employment taxes on Page One of their personal tax return.
Another great thing about the sole proprietorship being classified as a business is the ability to take part in the Qualified Business Income deduction.
This deduction is relatively new but so important to new business, especially small ones like many sole proprietorships are. With this new deduction, sole proprietors are able to exclude 20% of their business income from the tax calculation mentioned above.
In essence, the government is only taxing 80% of your business income, which is a great deal.
Also, of note is the fact that sole proprietorships require some basic tax planning. The government does not like it when you have huge business profits and haven’t paid tax on those profits throughout the year.
As such, they’ve established basic rules relating to how much tax should be paid in per quarter based on that untaxed business income. These quarterly estimates are a useful tool at eliminating any surprises by large tax bills in the middle of April.
Not sure how to calculate your quarterly estimated tax payments or just need a gut check? We’ve got you covered.
We can walk through the process, making sure we’re using the best estimates for your tax payments.
We take your goals into consideration and realize that liquidity is very important in a small business, so we ensure that your estimates make sense for you personally.
Needless to say, there are many moving parts when it comes to even simple entity structures like the sole proprietorship.
The brief blurbs above give outlines as to what you should be considering when starting your sole proprietorship, but the professionals at Savvy & Suite are here to act as your knowledge resource, whatever the question may be.
We’ve got loads of experience and can help you navigate through any time in your business’ life cycle.