It’s not uncommon for entrepreneurs to launch small businesses as sole proprietors. However, it’s crucial to understand the potential tax impacts first.
Here are 9 things to consider.
1. The pass-through deduction may apply
If your business generates qualified business income, you could be eligible to claim the 20% pass-through deduction. (Of course, limitations may apply.)
The significance of this deduction is that it’s taken “below the line”. It reduces taxable income, as opposed to being taken “above the line” against your gross income.
Even if you claim the standard deduction instead of itemizing deductions, you may be eligible to take the deduction. Unless Congress acts to extend the pass-through deduction, though, it will only be available through 2025.
2. Expenses and income should be reported on Schedule C of Form 1040
Whether you withdraw cash from your business or not, its net income will be taxable to you. Business expenses are deductible against gross income, rather than as itemized deductions.
If your business experiences losses, they’ll be deductible against your other income. Special rules may apply in relation to passive activity losses, hobby losses, and losses from activities in which you weren’t “at risk”.
2. Self-employment taxes apply
In 2024, sole proprietors must pay self-employment tax at a rate of 15.3% on net earnings from self-employment up to $160,600. You must also pay a Medicare tax of 2.9% on any earnings above that. If self-employment income is in excess of $250,000 for joint returns, $125,000 for married taxpayers filing separate returns, or $200,000 in other cases, a 0.9%
Medicare tax (for a total of 3.8%) will apply to the excess.
Self-employment tax is charged in addition to income taxes. However, you may deduct half of your self-employment tax as an adjustment to income.
4. You’ll need to make quarterly estimated tax payments
In 2024, quarterly estimated tax payments are due on April 15, June 17, September 16, and January 15.
5. 100% of your health insurance costs may be deducted as a business expense
This means the rule that limits medical expense deductions won’t apply to your deduction for medical care insurance.
6. Home office expenses may be deductible.
If you use a portion from your home to work, perform management or administrative tasks, or store product samples or inventory, you could be entitled to deduct part of certain expenses, such as:
- Mortgage
- Interest
- Rent
- Insurance
- Utilities
- Repairs
- Maintenance
- Depreciation
Travel expenses from a home office to another work location may also be deductible.
7. Recordkeeping is essential
Keeping careful records of expenses is key to claiming all of the tax breaks to which you’re entitled. Special recordkeeping rules and deductibility limits may apply to expenses like travel, meals, home office, and automobile costs.
8. Hiring employees leads to more responsibilities
If you’d like to hire employees, you’ll need a taxpayer identification number and will need to withhold and pay over payroll taxes.
9. Establishing a qualified retirement plan is worth considering
Amounts contributed to a qualified retirement plan will be deductible at the time of the contributions and won’t be taken into income until the money is withdrawn.
Many business owners prefer a SEP plan since it requires minimal paperwork. A SIMPLE plan may also be suitable because it offers tax advantages with fewer restrictions and administrative requirements. If neither of these options appeal to you, you may still be able to save using an IRA.
Questions? Smolin can help.
For more information about the tax aspects of various business structures or reporting and recordkeeping requirements for sole proprietorships, please contact your Smolin accountant.