Although the COVID-19 pandemic has forced many businesses to close, there are still some entrepreneurs who have started new small businesses this year—and many begin by operating as sole proprietors. If this describes you, here are a few tax rules and considerations.
QBI deductions
You’re eligible to claim the pass-through or qualified business income (QBI) deduction, subject to limitations, to the extent your business generates qualified business income. This deduction can be up to 20% of the pass-through entity owner’s QBI for tax years through 2025. You can take this deduction even claim the standard deduction instead of itemizing deductions on your tax return.
Filing as a sole proprietor
If you’re a sole proprietor, you’ll need to file Schedule C with your Form 1040. Any business expenses are deductible against gross income, while losses (if you have them) are generally deductible against your other income—though this is subject to special rules related to passive activity losses, hobby losses, and losses in activities where you weren’t “at risk.”
You’ll also need to get a taxpayer ID number and withhold and pay employment taxes if you hire employees.
Taxes for self-employment income
For 2021, you’ll need to pay Medicare tax on all earnings and Social Security on net self-employment earnings up to $142,800.
In addition, there is a 0.9% Medicare tax imposed on self-employment income that is:
- In excess of $250,000 for joint returns
- In excess of $125,000 for married taxpayers who are filing separate returns
- In excess of $200,000 in all other cases
Although self-employment tax is imposed in addition to income tax, half of your self-employment tax can be deducted as an adjustment to your income.
Estimated tax payments
Generally speaking, sole proprietors will need to make quarterly estimated tax payments. In 2021, these payments will be due on April 15, June 15, September 15, and January 17, 2022.
Deducting a home office
If you work or perform management or administrative tasks from a home office, or if you store inventory or product samples at your home, you may be able to deduct an allocable portion of some home-maintenance costs.
Deductions for health insurance
100% of your health insurance costs can be deducted as a business expense—so your deduction for medical care insurance isn’t subject to the rule limiting deductions for medical expenses.
Recordkeeping and tax breaks
To ensure that you’ll be able to claim all the tax breaks you’re entitled to, you’ll want to keep thorough and complete records of income and expenses. Certain expenses, such as automobile, travel, meals, and office-at-home expenses, are also subject to special deductibility limits or recordkeeping rules and require special attention.
Qualified retirement plans
Qualified retirement plans can be a worthwhile option to consider—amounts contributed to these plans are deductible at the time of contribution and are only taken into income after they’re withdrawn. Compared to many qualified plans, SEP plans can be attractive because they require less paperwork. SIMPLE plans are also available to sole proprietors and come with the bonus of tax advantages that have fewer restrictions and administrative requirements. You may also still be able to contribute to an IRA, even if you don’t establish a qualified retirement plan.
Questions? Contact us today
If you need more information about the tax aspects of starting a small business, or need assistance with reporting or recordkeeping requirements, contact us today—we can help guide you through the process.