Should You Designate Your Business as a Sole Proprietorship?

 

Is a sole proprietorship right for you? Learn more about this business structure.

• A sole proprietorship is a business that is owned and operated by a single person, with no legal separation between the owner and their business.
• Though a sole proprietorship is simpler than other business structures, it comes with some major drawbacks.
• Earnings from a sole proprietorship are taxed along with the business owner's personal taxes.
• This article is for entrepreneurs who are considering setting up their business as a sole proprietorship.

At the start of your small business journey, you need to determine your business's legal structure before registering it, since your business structure will affect everything from how you pay taxes to the amount of liability you take on. Some structures are more complex than others, but if you're looking to strike out as the only person responsible for your business, then a sole proprietorship may be the best-suited structure for you. Merchant Cash Advance Application

What makes up a sole proprietorship?

A sole proprietorship is a business that is owned and operated by a single person, with no legal separation between the owner and their business. A business automatically becomes a sole proprietorship if it is registered without a designated business structure.

When setting up a sole proprietorship, there are some associated costs involved, depending on the type of business you're starting. At the state and federal levels, there are licensing fees. Over time, other costs include business taxes, operating costs, and capital improvements or equipment purchases, among other things.

Key takeaway: A sole proprietorship is the default legal structure. It gives the business owner complete control over the company.

How are sole proprietorships taxed?

Since a sole proprietorship is not considered a separate legal entity by the IRS, taxes for this type of business structure are relatively easier than others. When filing a 1040 or 1040-SR, the business owner of a sole proprietorship must include a Schedule C form to report the business's income or losses.

According to the IRS, a business's profits are calculated by adding all profit and income, then subtracting the costs of goods and services, in addition to other business expenses incurred during the tax year. That figure is added to Line 12 of the business owner's 1040. If the business brought in positive revenue, that income is added to the owner's personal income and taxed accordingly. If a business operates in the red, however, those losses are also reflected in the owner's taxes, resulting in a potentially reduced total adjusted gross income. Apply for a Merchant Cash Advance

The taxation of a sole proprietorship works differently in each state. As such, you're going to have to consult your state's tax laws before filing for the first time. You may also want to consult a CPA if your budget allows. As a general rule, states often charge a sales tax and an excise tax. In addition, any property or real estate occupied by the business could have related tax obligations levied against it.

Sole proprietorships have access to some of the same credits and deductions that other businesses enjoy. Other tax deductions include health insurance deductions for Merchant Cash Advance the business owner, their spouse and their dependents. The IRS also says "ordinary and necessary" operating expenses can be deducted on a tax return.

Furthermore, once the Tax Cuts and Jobs Act of 2017 became law, sole proprietors were able to utilize new pass-through tax deductions of up to 20% of net business income earned each year until 2025. These deductions are considered additional personal deductions as long as you meet the federal government's guidelines.

Personal tax impacts

Once you collect any income from the business, you're going to pay taxes on it. As the only person in the company, you're going to have to withhold and file self-employment taxes and ensure you have enough money at the end of each quarter to pay an estimation of what you owe to the IRS.

By estimating and setting aside how much money you need to cover your taxes, you will avoid any problems with the IRS. You do that by using the IRS' 1040-ES form. An estimated tax will be required if the two following statements are true Merchant Cash Advance Loan Application

1. You expect you'll owe at least $1,000 in taxes after subtracting your withholding and refundable credits.
   
   
2. You expect your withholding and refundable credits to be less than the smaller of 90% of the taxes shown in your next tax return or 100% of the taxes shown on your tax return from the previous year if it covers all 12 prior months.

Self-employment tax is calculated using the Schedule SE form. Not unlike a payroll tax at larger companies, the self-employment tax covers both Social Security and Medicare taxes, with the total self-employment tax rate currently sitting at 15.3%, with 12.4% going to Social Security and 2.9% going to Medicare.