Tax deductions are your friend

There’s a lot of complicated and conflicted information out there.

Between the IRS website and the sites with a bunch of ads, it is so difficult to understand what it is that a sole proprietor needs to do to understand the tax implications of running their business.

That’s why we decided to create this guide – no ads, no fluff, or technical terms just straight to the point information that is easy to understand.

Do we have your attention? 

Good. 

As a sole proprietor, you are looking for any way to cut expenses and add to your bottom line. 

We get it. So let’s talk about sole proprietor tax deductions. 

Here’s the short story: more deductions = fewer taxes. 

Now that you’re excited let’s read on!

Other than rent and payroll, sole proprietorship taxes will be one of your largest expenses each year. According to the balance small business, sole proprietorships face a 13.3% tax rate.

It’s in your best interest as a sole proprietor to use and maximize the tax deductions. They’ll lessen your tax burden, allowing you to invest that money in your business.

Filing taxes as a sole proprietor isn’t easy, but don’t worry. We’re here to help. 

First off, we’ll walk through the basics of an IRS sole proprietorship and how it is taxed. Then, we’ll be going in-depth on several tax deductions you need to know about and how to take advantage of them. 

How do I know I am a sole proprietor?

Great question. It’s important to establish if you are a sole proprietor to determine your tax obligations. This is necessary so you can calculate your deductions!  

A sole proprietorship is not limited to a specific industry. In its most basic form, a sole proprietor runs and operates their own business. It is not established as a legal entity, therefore all the financial and legal obligations fall upon the owner. 

Even if you do projects as an independent contractor for one or two firms, it’s very likely you are a sole proprietor. Typically, companies do not withhold taxes from an independent contractor’s wages. If no one is withholding your taxes, most likely you’re a sole proprietor. 

The beauty of being a sole proprietor is the simplicity of setup. It’s by far the easiest company to start because essentially, all you need is yourself and a skillset. To give you some ideas, here is a sample of a sole proprietorship business

  • Computer repairs services 
  • Freelance writing or graphic design 
  • Landscaping or lawn company 
  • Photography

Do sole proprietors pay quarterly taxes?

If you’re new to working for yourself, there will be some familiarity with how your taxes work.

Like most W-2 employees, you’ll have to file your sole proprietorship taxes annually (usually April 15th).

One major difference is the payment of quarterly estimated taxes. These are made each quarter to help satisfy your tax obligations since you do not have an employer taking this money out of your paycheck.

If you work with an accountant, they can help you determine your sole proprietor taxes for each quarter. 

To make accurate payments, you’ll need to know your net profit or loss. The IRS requires payment on any net income above $400 earned each year.

How does a sole proprietorship pay taxes?

Now that you know you’re a sole proprietor, it’s important to start thinking about taxes. We know this isn’t the most fun topic.

We’re going to break it down and help make the process a little easier. 

The easiest way to pay your sole proprietor taxes is to visit the IRS website and pay electronically. You can use either your bank account, a debit or credit card. By using your bank account, you can schedule payments in advance. Those paying with debit or credit card also have the option to call and make a payment. 

You can send a check, although online is the quickest option.

If you’re unable to meet your tax obligation, you can set up a payment plan. Note that this may include interest and late fees. 

Don’t forget to check out your state’s Department of Revenue site. They manage state sole proprietorship taxes and that is where you will need to make your state payment. While you may owe fewer state taxes than federal, it’s important to take care of it.

Do sole proprietors charge sales tax?

The answer depends on the type of business you operate. According to the balance small business, sole proprietors do pay sales tax on goods and products they sell. So if you’re running a flower shop or online store, you’ll be required to pay state taxes on the goods you sell. Your tax rate will vary based on the state you live in. 

If you’re a writer or graphic designer, you won’t have to pay sales taxes on your services but you will owe state sole proprietorship taxes on the revenue you earn.

How does a sole proprietor get a tax refund?

A sole proprietor’s best chance of getting a refund is overpaying on your quarterly estimated payments. By paying more than what you believe you owe, you increase your chances of receiving a refund once you file your return. 

As stated in the balance small business, if you do pay extra in hopes of a refund, you forego the opportunity to use that money elsewhere throughout the year.

What can you write off as a sole proprietor?

Now for the good stuff. Let’s talk about the deductions you can use when filing taxes as a sole proprietor.

You may have a lot of questions, like, “how much of my phone can I claim on my taxes?” or “Can you write off a home repair?”

IRS sole proprietorship guidelines go through each of these. But, to save you some time (because we know how precious that is as a business owner), we’ve put together a list of important deductions you need to know about. Using this will help you reduce the burden of your sole proprietor taxes.

Are startup costs tax-deductible?

At this point, you’re well aware that starting a business is a challenge.

And it’s expensive.

Fortunately, you can deduct some of your startup expenses. The IRS will allow claims of up to $5,000 in your first year of operation. These costs vary but include advertising, travel, and fees associated with professional services or consultants. 

The IRS recommends treating all your startup costs as capital expenses. While you can deduct interest and taxes in some circumstances, they cannot be deducted as startup costs on your sole proprietorship taxes. 

Costs of getting your business started

A sole proprietorship has one of the lowest barriers to entry for starting up. But, like any business, you will invest some money to get your idea off the ground. Many of these expenses can be deducted from your sole proprietor taxes. 

Most businesses need a website. Whether you build the site yourself or pay an expert, there are costs associated with getting a site launched. You need to register a domain name, build out landing pages, and more. Each of these items has a cost. The great news is you can deduct each as a business expense on your sole proprietorship taxes.

Even after your first year of business, as long as you use that site for your work, you can continue deducting the costs of your website.

Depending on the technology, you can have deductions on things like printers and computers.

You have the option, under Section 179, to write this off the year of purchase, or over several years. Software purchases can qualify as well.

This does not include personal items. Sorry, no deduction for playing Minecraft. 🙂

Depending on your industry, you may want to invest some money in advertising. This could be anything; digital, print, or podcasting. The costs of placing an ad can be deducted on your sole proprietor taxes. 

Continued education

Maybe you want to take a few classes to broaden your skillset.

You can deduct the cost of your own education. Classes that maintain or improve skills in your current field can be deducted.

You need to be able to show that the knowledge you gained maintains or improves the skills required by your job.

Taking a cooking class if you’re an accountant is probably not going to qualify as deductible (but it may save you money on client dinners).  

Deductions for your health insurance

You’ve likely purchased health insurance through a private carrier or the Healthcare Exchange.

In most situations, you’ll be able to claim a deduction on any health, dental, and qualified long term care insurance you’ve purchased.

This can include you, your spouse, and any dependents. Not only are these good investments, but they are a great deduction on your sole proprietorship taxes.

Writing off Social Security and Medicare taxes

For most W-2 employees, their employer manages the deduction of Social Security and Medicare from their paycheck.

As a sole proprietor, you’ll have to take care of this on your own. You can claim a deduction of 50% on your quarterly social security and Medicare payments made throughout the year.

Retirement Plans

Contributing to a retirement account is a no brainer. As a sole proprietor, it’s even more important to stay on top of your savings. The IRS allows you to deduct some of your contributions on your taxes. 

Let’s take a look at two of the more popular plans and their impact on your sole proprietorship taxes. 

 

  • Roth IRA: Contributions to a Roth IRA account are not deductible. 
  • Traditional IRA: You’re allowed to take a full deduction of your contribution if you or your spouse (if you’re married) are not covered by an employer retirement plan. 

The rules get a little tricky with sole proprietor taxes. The deduction can vary based on the plan you choose and if you contribute to an employee’s plan. 

The IRS has an entire page dedicated to self-employed retirement plans. It includes the various deduction possibilities for each retirement plan, from 401Ks to Roth IRAs.

It pays to work in your PJs

It’s very likely in our current environment that you’re working from home. Maybe that’s always been your office. Since you use this space for a business, it can be claimed as a deduction. The IRS uses two methods for home office deductions: the Simplified Method and the Regular Method. No matter which you choose, there are two basic criteria: Your home office needs to be your regular place of business and be exclusively used for these purposes. It is your principal place of business.  We’ll answer the questions of how to calculate home office appreciation and deduction.  If you have a home office, or room that is used as such, this will qualify as a space that can be deducted. If you’re working out of your kitchen or dining room, things may get a little trickier since you do other activities there.  Maybe you’re a road warrior or also use a co-working space for client meetings. This is perfectly fine, as long as you still do substantial business in your home and calculate it accordingly.     
  • Simplified Method: 
    • This became an option in the tax year 2013.  
    • While it does not change the criteria of qualification, it simplifies the calculation.  
    • The standard deduction is $5 per square foot (up to 300 sq. feet). 
    • Certain expenses may qualify such as mortgage interest and real estate taxes.
    • This method keeps it simple by reducing the amount of record-keeping. 
  • Regular Method: 
    • If you go the regular route, you’ll have to determine each expense associated with your home office (utilities, mortgage interest, insurance, etc.) 
    • Instead of cost per square footage, the deduction is calculated on the percentage of your home devoted to business usage. 
    • Using the regular method, you may be able to claim direct and indirect expenses on your taxes. 
Here’s a full list of allowable deductions from your home office: 
  • Rent 
  • Casualty losses 
  • Mortgage interest 
  • Insurance 
  • Utilities 
  • Depreciation 
  • Maintenance & repairs 
These write-offs typically fall into two categories; they are either direct or indirect expenses. Direct expenses are related exclusively to the business area of your home, so repairs and maintenance to your office would qualify as a direct expense. These are typically fully deductible.  Indirect expenses relate to your entire home. Things like insurance and utilities are indirect because you utilize them for both business and personal use. You’ll need to calculate the percentage usage of these expenses as it relates to your business to determine the allowable deduction. 

Can you really write off home repairs?

You can write off home repairs that are directly related to your home office. Maybe you built some shelving, a new desk, or applied a fresh coat of paint. These are deductible expenses. 

Unfortunately, writing off the new countertops in your kitchen will not qualify as an allowable deduction.

What percentage of utilities can I claim?

That was probably one of the first questions on your mind when you saw utilities on the list.

Since utilities in your home overlap with personal use, you’ll need to determine the percentage use of your home for business. You can use that calculation to determine how much of your utilities you can write off.

How to calculate home office depreciation?

The IRS does allow depreciation on the part of your home used for business, but you can’t depreciate the cost or value or the land. It’s important to know a few things before depreciating your home: 

 

  • The point in time you started using your home for business. 
  • The cost of improvements made before and after you started using it for business. 
  • Percentage of your home used for business. 

 

You must know the percentage of your home that can be depreciated for business use. Then, you’ll want to multiply the percentage of your home that is used for business by the lesser of the following: 

  • The adjusted basis of your home when you started using it for your business. 
  • Or the fair market value when you used it for your business. 

Determining home office deduction method

If you’re wondering which method is best for you, whip out your calculator (AKA your cell phone) and do a little math. If the estimated deduction is about the same, you’ll likely save yourself some time and stress by using the simplified method.

No matter which you choose, this is one of the best deductions to claim on your sole proprietorship taxes. 

Special exceptions apply to daycares. If you use your home for the care of children, persons over the age of 65, or those unable to care for themselves, you can still use a home deduction. You need to determine the percentage of your home used for daycare. 

What if you rent?

Since we’ve talked about home office space, this may raise a question: “I’m a renter. Can I deduct rent on my sole proprietor taxes?”

The short answer is, yes. The same requirements apply to the business use of your home. 

If you rent space (an office, co-working desk, store, etc.) you can use this as a deduction. 

The IRS does have a caveat on what they refer to as “unreasonable rent.” Meaning, if you’re renting space from someone to whom you’re related, you need to pay them the same amount you would a stranger landlord. This situation typically only arises if you’re related, in some way, to the owner of the property.

Deductions for your phone

If you’re running a business, you probably wonder “how much of my phone can I claim on my taxes?” After all, it’s a big part of your operation. And cell phones aren’t getting any cheaper (like we said earlier, it doubles as your calculator). 

The IRS does not allow you to deduct the costs of the first telephone line in your home. You can deduct the expense of long-distance calls or the use of an exclusive business phone.

Deducting your mileage and travel costs

Although you may mostly work at home, or in an office, as a sole proprietor, you probably use your vehicle for business purposes; driving to meetings, conferences, business meals.

You may also use that vehicle for your personal life. If so, you’ll need to calculate the percentage usage for your business. 

Mileage can be deducted. This relates to trips outside of your normal commute or within the general area of your business and residence.

In 2019 the standard mileage rate was 58 cents per mile. In 2020 it is 57.5 cents.

Meals

Ah, the client dinner. Or lunch. Maybe coffee. Love them or hate them, these meetings can add up in cost. You can typically qualify for a 50% deduction of the costs associated with meals and entertainment. Traveling to these meetings is a separate expense and not subject to the 50% rule. 

Traveling for business is often a great time to enjoy some personal time and sightseeing. If you incur any expenses on your trip that are not related to the business (i.e. going to a sporting event or visiting a museum) then you cannot deduct those as part of your trip.

Is coffee a business expense?

If you’re a coffee-lover, you’re in luck. You can deduct your coffee expenses in certain conditions. Kiro Coffee gives a great breakdown of how to write off your coffee addiction. 

If you’re making a run to your local coffee shop for an afternoon pick me up, this is not deductible. But if you’re meeting someone there for a meeting, you can write off 50% of this cost. 

If you buy brewing equipment or coffee for use at your home office, this qualifies as a deductible expense on your IRS sole proprietorship taxes.

Depreciating assets (Codeword: Section 179)

For most sole proprietors, it’s unlikely you have a large number of assets with the depreciation that can be deducted.

Let’s touch on this briefly so we cover our bases. Beginning in the tax year 2020, you can deduct a maximum of $1,040,000.

The most likely application for your sole proprietorship is depreciation on a vehicle. A vehicle you use for work, and first placed into service in 2019, can have a maximum depreciation deduction of $10,100. 

Impairment expenses

If you’re an individual with an impairment, you may use services or tools to help you with business tasks. If the assistance is exclusively used for business, you can deduct the costs on your sole proprietorship taxes. 

Maybe you need a computer to type documents and emails and are unable to do so yourself. Purchasing a dictation software that is used for your business would qualify as a deductible expense. 

Bad debts, interest on loans, fees, oh my...

Hopefully, this doesn’t happen often, but you may have a client who cannot pay a debt they owe you. 

You can only claim a bad business debt if it was previously reported on income. 

You can generally deduct interest on loans you intend to repay. This is particularly useful if you’ve taken out a mortgage to purchase your place of business. You can deduct the expenses used to obtain a mortgage (again, if you use that property for business purposes) from your sole proprietor taxes. You can also deduct the interest you pay on the mortgage. 

If you take out a credit card for your business, you have the opportunity to claim fees as a deduction. Oftentimes these come in the form of annual fees for usage. 

Clubs and organizational fees

You may join a networking group, chamber of commerce, or trade association. These are great ways to get the word out about your services and meet other professionals. If these types of organizations are established to serve a business purpose, their fees can be deducted. 

This is an exception to the IRS’ rule that club feeds are non-deductible. Sorry, your golf course membership didn’t make the cut.  

Helping you help yourself

There are a number of things you can do to make tax season less panic-inducing: 

  • Keep track of your records. Digitally, or hard copy (preferably both). Be sure you hang on to this info. Save your receipts, invoices, statements, and keep them organized. This will make it much easier to access and help you take advantage of all possible deductions. 
  • Find a good accountant or bookkeeper and hire them. It’s worth the investment to make sure you file correctly and take advantage of all these sole proprietorship tax deductions. You may not be very good at maintaining records, that’s okay. An experienced bookkeeper will make your life much easier and help avoid any critical mistakes. Your accountant will appreciate the bookkeeper’s work when it’s time to file taxes. Bonus: the cost of these services is deductible.
  • Keep your business and personal expenses separate. Things can get complicated if you blur these lines. The purchases you make with business income should primarily support your business activities (Hint: going out to lunch for yourself on the business account is not going to be a deductible expense). 

COVID-19 considerations

Due to the ongoing pandemic and economic crisis, the IRS has delayed the 2019 tax deadline until July 15, 2020.

Check out their People First initiative page for more information. They’re making exceptions to help during this difficult time, including payment plans and giving those who owe delinquent bills a break.

Many state governments have altered their tax deadlines, so check with your Department of Revenue for more info.

Additional resources for the sole proprietor

The IRS recently launched their Gig Economy Tax Center. It provides resources and tax help to workers who provide on-demand services. This is a great way to learn more about your tax obligations as a sole proprietor. 

Given the rise of gig jobs, IRS sole proprietorship resources have been made readily available. From ride-sharing services to online creative market places, more people than ever are earning income through side gigs. 

This type of work is generally categorized as being part-time, or temporary, and often done through digital platforms. Services like freelance writing, photography, or design work could fall into this category. Others may sell handmade goods through online marketplaces like Etsy or Uncommon Goods. 

There are tax implications for anyone who works in these fields. Whether gig work is your full-time business or just a side hustle, you’ll need to pay taxes on this income. The IRS suggests keeping track of all expenses to help lessen the burden of your sole proprietorship taxes. 

On the income side, you need to keep track of what you’re earning (this is just good business practice). Even if you don’t receive a 1099 tax form from those with whom you’ve worked, you’ll still need to report this income. 

Solopreneur doesn’t mean you’re in this alone

Tax season sends a shudder down the spine of even the most financially savvy. Many people stress about affording their tax bills or getting everything correct on their return. Filing taxes as a sole proprietor does not have to be a lonely journey.

There’s a lot of information out there, but arming yourself with a good bookkeeper or accountant will make the process much easier. 

Even if you’re capable of managing your own records, consider purchasing a reliable bookkeeping software so you have everything in one place. We can’t express enough how important it is to maintain good records for your sole proprietorship taxes. Your life will be much easier by April 15 (or July 15 in 2020). 

Practice good habits with your business income. View your taxes as a way to reduce the expenses in your business. When you’re running a sole proprietorship, taxes can be one of the few major expenses you have a direct ability to change. Rent, payroll, insurance, are all difficult to reduce. By being diligent in how you run your business, you can greatly lessen the impact of taxes on your bottom line. 

We’ve covered a lot in this article. From questions like, “how much of my phone can I claim on taxes?” to writing off your coffee habit. Keep an eye on our blog for more great tips to manage your sole proprietorship. Use these tax deductions to your advantage as you grow your business.

LessAccounting wants to help sole proprietors do what they love. This means less time sweating the details like taxes and deductions. 

Easy Accounting Tips

  • KISS. Keep it simple starting out. The simplest form of entity for running your first business is called a sole proprietorship. This form of ownership requires NO special communication or filings to the Internal Revenue Service until you start paying employees.
  • As a sole proprietor, you are the owner/entity which might require only to acquire an occupational license if your county or municipality mandates one. As the owner, you are also liable to remit all state or city tax collections on retail or wholesale sales your business collects. Service businesses and most cross state sales are exempt from state tax collections.
  • If you are concerned about personal liability as a sole proprietorship then do the cheapest and simplest thing which is to buy a personal liability umbrella policy. The best way to avoid liability is to learn your trade well and keep accurate records on LessAccounting.
  • Concentrate on building your business not communicating with the IRS. As a sole proprietor, the IRS will not even know you exist until after you file your first personal income tax return. This return will include a Schedule C which communicates all of the sales and expenses you recorded in LessAccounting on your business. These sales and expenses do not have to be in a separate bank account as mandated by the LLC or Incorporation format. The sole proprietor losses offset your day job’s income to provide a possible tax refund.
  • Over 90% of small businesses fail or change ownership within the first five years. Plan your business to thrive but if it falls under a sole proprietor you simply stop doing business. No communication or special forms with the IRS, no additional taxes to get your investment returned and no high accounting fees to close out your entity. Simply file a final Schedule C with your next personal return. KISS.
  • How do you get paid as a sole proprietorship? Simply take the money out as a draw. No payroll taxes or quarterly forms needed. Most startups lose money for the first several years, so keep your day job to pay your living expenses.
  • Know that a “write off” doesn’t mean that expenses are free, it only means you can save paying some taxes on that income if you spend it for certain purposes. Small Business Tax Tips… What You Can And Cannot Deduct.
  • After you pass the five-year hurdle, then you can talk with a CPA about another entity type that might save you taxes. Again a simple bookkeeping entry transfers all of the business assets from the sole proprietorship into the new entity without any tax penalties. Then quit your day job to celebrate your new livelihood.

General Small Business Tips And Advice

IRS Resources:

About Publication 587, Business Use of Your Home (Including Use by Daycare Providers). (n.d.). Retrieved from https://www.irs.gov/forms-pubs/about-publication-587

Easy ways to pay taxes. (n.d.). Retrieved from https://www.irs.gov/newsroom/easy-ways-to-pay-taxes

Home Office Deduction. (n.d.). Retrieved from https://www.irs.gov/businesses/small-businesses-self-employed/home-office-deduction

Publication 535 (2019), Business Expenses: Internal Revenue Service. (n.d.). Retrieved from https://www.irs.gov/publications/p535#en_US_2019_publink1000209195

Publication 535 (2019), Business Expenses: Internal Revenue Service. (n.d.). Retrieved from https://www.irs.gov/publications/p535#en_US_2019_publink10007487

Publication 535 (2019), Business Expenses: Internal Revenue Service. (n.d.). Retrieved from https://www.irs.gov/publications/p535#en_US_2019_publink1000209188

Publication 535 (2019), Business Expenses: Internal Revenue Service. (n.d.). Retrieved from https://www.irs.gov/publications/p535#en_US_2019_publink1000208843

Publication 535 (2019), Business Expenses: Internal Revenue Service. (n.d.). Retrieved from https://www.irs.gov/publications/p535#en_US_2019_publink1000208843

Self-Employed Individuals – Calculating Your Own Retirement-Plan Contribution and Deduction. (n.d.). Retrieved from https://www.irs.gov/retirement-plans/self-employed-individuals-calculating-your-own-retirement-plan-contribution-and-deduction

Topic No. 509 Business Use of Home. (n.d.). Retrieved from https://www.irs.gov/taxtopics/tc509

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