Many people who start small businesses embark on the adventure as sole proprietors. Despite the overwhelming amount of information, here are nine basic tax rules that should be foremost in your focus and consideration when operating as that entity.
- Do you qualify for the pass-through deduction? As your business grows and generates qualified income, you are allowed to claim the 20% pass-through deduction, although it is subject to limitations. The pass-through deduction is used to reduce taxable income, rather than being taken against the gross income. However, it is possible to take the deduction even if you decide not to itemize those deductions and prefer instead to claim the standard deduction.
- Did you report income and expenses on Schedule C of Form 1040? The net income of your business will be taxable whether or not you withdraw cash from your company. Business expenses are always deductible against gross income, but are not necessarily listed as itemized deductions. Conversely, any losses to your business will generally be deductible against your other income. These deductions are subject to special rules related to hobby losses, passive activity losses, and losses in activities in which didn’t create risk.
- Do you pay self-employment taxes? For 2020, sole proprietors pay self-employment tax at a 15.3% rate on the net earnings from self-employment up to $137,700. Medicare tax is set at a 2.9% rate on any excess income. There is an additional 0.9% Medicare tax (for a total of 3.8%) that is imposed on self-employment income that is larger than $250,000 for joint returns, $125,000 for married taxpayers filing separate returns and $200,000 in all other cases. Self-employment tax is in addition to income tax, but you can deduct half of your self-employment tax as an adjustment to income.
- Do you make quarterly estimated tax payments For 20202, these tax payments are due April 15, June 15, September 15 and January 15, 2021.
- Can you deduct home office expenses? If you work from a home office, you may be able to deduct some of the costs of maintaining your home. Acceptable business tasks at home may include management or administrative tasks or storing product samples or inventory at home. You may also be able to deduct travel expenses between your home office and other work locations.
- Did you know you can deduct 100% of your health insurance costs as a business expense? This good news means that any deduction for medical care insurance is not subject to the tax rules that limit medical expense deductions.
- Are you keeping complete records of your income and expenses? It is crucial that you carefully record your expenses so that you can claim all the tax breaks for which you may qualify. Some business expenses are subject to special recordkeeping rules or deductibility limits, so be sure to study those carefully.
- If you hire employees, you need to get a taxpayer identification number and withhold and pay employment taxes.
- Have you considered establishing a qualified retirement plan? Retirement plans may not feel like an urgent business expense, but they provide several advantages. For example, any amount contributed to a retirement plan is deductible at the time of the contribution. Additionally, those deductions are not counted as income until they are withdrawn. Because many qualified retirement plans can be tricky, you might consider a SEP plan, which requires less paperwork. A SIMPLE plan is also available to sole business owners, and it offers tax advantages that have fewer restrictions and administrative requirements. And if you choose to forego a retirement plan, you always have the option to contribute to an IRA.
If you want additional information regarding the tax aspects of your new business, or if you have questions about reporting or recordkeeping requirements, please call us at 818-334-8636 or click here to contact us. We look forward to speaking with you soon.