Sole Proprietorship Tax

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As a sole proprietor, how do I account for and pay taxes?  

What are some of the main tax advantages of a sole proprietorship?  

What are some of the main tax disadvantages of a sole proprietorship?

   

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As a sole proprietor, how do I account for and pay taxes? back to top

If you carry out your business activities as a sole proprietor, your business expenses, losses, and profits are accounted for and taxed along with all other personal income on your individual federal and state income tax statements and at your personal income tax rate. The expenses and losses are generally directly deductible against other personal income. For tax purposes, income and expenses associated with your business are reflected on either Schedule C, Profit (or Loss) from Business, or Schedule C-EZ, Net Profit from Business, submitted with your federal and state Form 1040 personal income return.

Personal income tax, however, is a “pay as you go” system of taxation. Whereas employees have personal income taxes withheld from each employee paycheck by their employer, the sole proprietor is responsible for directly paying his or her own personal income taxes as a self-employed individual. These estimated taxes are due quarterly and are generally based on his or her self-employment income from the prior year. Thus, when the sole proprietor’s tax returns are prepared for the preceding tax year, quarterly estimated tax payment statements are also created at that time by the sole proprietor or his or her accountant, with any increases or decreases from the prior year’s self-employment income to be reconciled in the final quarter, when his or her personal annual return is due.

More specifically, a trademark identifies and distinguishes a manufacturer's or seller's goods from the goods of others. A service mark identifies and distinguishes a seller's services.

What are some of the main tax advantages of a sole proprietorship? back to top

Advantages of sole proprietorship taxation include:

1. A separate tax return is not required for the sole proprietor’s business activities. Rather, expenses, losses, and profits are accounted for and taxed along with the other personal taxable events of the sole proprietor.
2. Individuals and individuals operating as limited liability companies taxed as sole proprietors may generally use business losses to offset non-business income.
3. Individuals and individuals operating as limited liability companies taxed as sole proprietors may generally contribute assets to their businesses and distribute assets from their businesses to themselves without having to recognize gain or loss in income. In other words, no sale of the assets is assumed in the transaction and the sole proprietor's tax basis in the assets remains the same. This allows sole proprietors greater flexibility in using their assets, particularly when those assets are utilized at different times. However, where an individual organized as a limited liability company is being taxed as a sole proprietor caution must be exercised against too casually commingling one’s personal and business assets. Such transfers should be documented as distributions or asset assignments in bills of sale or assignment agreements. If an individual owner does not recognize any formal difference, apart from tax considerations, between his or her assets and the assets of a limited liability company taxed as a sole proprietorship, neither might a court of law.
4. Sole proprietors (like partners and members in an LLC taxed as a sole proprietorship or partnership) are self-employed individuals and do not count as employees for the purpose of meeting worker’s compensation threshold (generally four or more employees within twelve months) or South Carolina Payment of Wages Act threshold (generally five or more employees)
5. As self-employed individuals, sole proprietors (like partners and members in an LLC taxed as a sole proprietorship or partnership) are not required to pay federal or state employment security taxes on their distributions.

What are some of the main tax disadvantages of a sole proprietorship? back to top

Disadvantages of sole proprietorship taxation include:

1. Exclusion from federal income tax advantages of C corporations regarding the deductibility of fringe benefits and payments for qualified retirement plans that are generally appropriate for larger companies.
2. Sole proprietors must pay social security and Medicare taxes on their net business earnings. Whereas, individuals who own corporations or limited liability companies may be able to reduce their self-employment taxes under certain limited circumstances by: (1) the election of Subchapter S tax status, (2) paying themselves a reasonable employee salary, and (3) distributing the remainder of the net income to themselves as distribution (see a competent business attorney or certified public accountant for important restrictions in doing so). While such distributions are subject to personal income taxation, distributions are not subject to social security and Medicare taxes.
3. When the business is sold, the Internal Revenue Service treats the sale as if the sole proprietor sold each individual asset. Gain or loss on each item must be computed. Intangible assets such as patents and copyrights are treated similarly.

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