As a sole proprietor, you are solely responsible for your business. You will need to encounter additional tax and reporting requirements, but you may also be eligible for certain tax deductions.
You are responsible for your business; you and your business are one when it comes to the tax code. While this implies certain freedoms, it also creates additional responsibilities. You will need to meet additional tax and reporting requirements, but you may also be eligible for certain tax deductions for businesses. Below are some of the deductions you can claim.
Health insurance deduction
One of the main tax advantages of a sole proprietorship is that you can deduct the cost of health insurance for you, your spouse, and your dependents. Better yet, you can make this deduction even if you don't specify the deductions on your tax return. The Medicare deduction is an "above the line" deduction, which is deducted from gross income before reaching adjusted gross income. Other deductions, such as itemized deductions, are "below the line" deductions.
The amount of your taxable income limits your deduction, so if you experience a loss in your business, you won't even be able to take advantage of your health insurance deduction. You cannot take a deduction for the months you or your spouse is eligible for group health insurance with an employer.
Business expenses
Every business encounters operating expenses, and a sole proprietorship is no different. As long as your expenses are "normal and necessary" in the language of the IRS, you can claim them on your tax return. Also, in addition to health insurance, common deductions include travel, utilities, equipment, subscriptions, and capital goods.
If you operate your sole proprietorship business from your home, you can probably claim the Home Office deduction. Certain daily expenses, such as rent and utilities, may be deductible. However, you should only use this section of your home for your business.
Self-employment tax
If you run your own business, you are responsible for your taxes in addition to normal income tax. Self-employment taxes are equivalent to social security and health insurance taxes that all employers and workers must pay. When you work for an employer, you only pay part of the employee's taxes, and the employer pays the other half. As the sole proprietor, you must pay employer and employee contributions. You can deduct half of the tax yourself.
Records and audits
The Internal Revenue Service tends to take a closer look at tax returns filed by sole proprietorships because it can easily blur the line between business and personal expenses. Even if your business and personal tax returns are combined, the IRS still expects you to keep accurate and separate business records. If you deduct the full price of your computer, for instance, the IRS may want to see records showing that the computer is used strictly for business purposes.
If your expenses surpass your income, you can expect a closer look from the IRS, especially if you haven't made a profit in at least three of the past five years. Don't be afraid to take a deduction to which you have a legitimate claim, but be sure to keep accurate records to support your claims, especially the Home Office deduction.
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