Of course, being your boss comes with its perks: Flexible working hours, flexible deadlines, control over your career trajectory, etc. However, those aren’t the only perks of a sole proprietorship. Running a one-person show has more advantages than you would expect.
For starters, it’s straightforward to set up. Low startup costs and no need for a formal structure make it simple to set up such a business entity. In addition, most individuals who have their own business don’t even know that they are considered sole proprietors by the IRS.
Secondly, if well-understood, tax preparation, and filing become much more straightforward when filing as a sole proprietor. For instance, in a sole proprietorship, there is no distinction drawn between your business and yourself.
In simple terms, you are considered both business and individual for tax purposes. In technical terms, this is known as a ‘pass-through’ entity—all business income passes through to the business owner.
Of course, this is taxable and must be declared in the individual’s tax return.
Who Is Likely to Be a Sole Proprietor?
Sole proprietorships generally do not require much in terms of brick-and-mortar start. Therefore, becoming an individual business owner can be easy.
Sole proprietorships are dominated by professionals who can work remotely or travel to customers. Common professions under this type of business formation include:
- Freelancers (photographers, web developers, copywriters, editors)
- Business consultants or public speakers
- Professional cleaners and organizers
- Home healthcare service providers (physiotherapists, personal trainers, at-home radiology services)
- Landscapers, etc.
What Sort of Taxes Do Sole Proprietors Need to Pay?
As a one-person team, sole proprietors are both bosses and employees. This means, when filing as a sole proprietor, there are a few additional taxes that you need to pay over and above your income taxes.
Sole proprietors are responsible for paying:
- Federal and state income taxes
All sole proprietors must declare their business’ profits and losses, as well as any other personal income. The IRS will decide tax brackets and tax bills based on the combination of these two factors.
- Self-employment taxes
If you were to work for an employer, you would have to withhold a certain amount of your pay, which is meant for FICA taxes (Social Service and Medicare). However, being your own boss means that you can make these contributions while paying your taxes.
- Federal and state estimated taxes
When employed in an organization, employers withhold taxes from your paycheck for you. On the contrary, as a self-employed individual, you must budget for estimated taxes owed for your business and pay them throughout the year. Ideally, you should estimate the total tax bill for the year, and make quarterly payments as required by the IRS.
Which Deductions Do Sole Proprietors Qualify For?
Like any other organization, business expenses are deductible and can reduce your tax bill. Therefore, keeping separate checkbooks for business and personal expenditures is a good habit to follow.
As long as you have accurate and detailed records of the money spent for profit, you can claim deductions for the following:
- Automobile and transport expenses
If you depend on your vehicle to keep your business running, you can deduct some of the expenditures you make to commute. You could choose to claim deductibles using either the Actual Expense Method or the Standard Mileage Rate.
- Start-up costs
Once your business is functional, there are many operational costs that business owners must incur to keep doors open: repairs, advertising, office supply purchases, and utilities.
These expenses can be deducted from your taxable income up to a limit of $5,000 for the first year you’re in business. After that, any remainders can be removed over the next 15 years.
- Professional and legal fees
Seeking professional help from lawyers, accountants, and consultants comes with hefty fees. Luckily, such services are deductible as long as you can provide a receipt and proof of service done for your business.
- Insurance
You can deduct any premiums paid toward insurance for health, property damage, loss from theft, etc., from your taxable income. This falls under the ambit of a business operating expense.
- Courses for continuous professional development
You may need to upskill from time to time to continue running your business. Therefore, any educational fees paid toward courses that enhance professional abilities are tax-deductible.
Also read: 14 Tax Breaks for Filing as Self-Employed NRI in the US
Which Forms You Must Submit for Your Tax Return?
Apart from the documents required for your tax filing, the following are required:
- Form 1040, Schedule C
You must fill the Schedule C, Profit or Loss from Business (Sole Proprietor) of Form 1040. The Schedule consists of five parts:
Part I: Income,
Part II: Expenses,
Part III: Costs of Goods Sold,
Part IV: Information on your Vehicle,
Part V: Other Expenses.
Business owners should keep the following handy:
- Business Income Statement
- Mileage records (if you plan on claiming deductions for the use of your vehicle to do business)
- Inventory count and valuation (if you sell any sort of product)
- Records and receipts of all expenses
- Schedule SE
If your business earned more than $400 worth of revenue in the year, as a sole proprietor, you must report and pay your FICA taxes (Social Security and Medicare).
Consulting a Tax Professional
Financial advisors can help you set goals according to your business needs while maximizing your tax savings. For instance, you may want to consult a professional to help you prepare for filing as a sole proprietor—-and AOTAX is the best out there for Indian professionals.
With close to 20 years of experience, we at AOTAX are well-versed in US taxation laws and how they apply to Indians working in the US. Therefore, we can help you optimize your tax strategy in the best way possible. Sign up for free today!
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