Tax Tips for Sole Proprietors

It’s great to be self-employed and operate your own business as a sole proprietor. You can turn your art or craft into a business and have the freedom to schedule your work whenever you want to do it. But being a sole proprietor or independent contractor comes with complex taxation and financial reporting obligations that go year-round. 

Tax time is pretty much all the time for the self-employed. While sole proprietors will receive a 1099 form from their contracting employers around January of each year, self-employment tax payments are due quarterly —every 3 months. So it’s critical to maintain monthly financial reports that are as accurate as possible.

Doing your taxes is different for sole proprietors. You still have to file the standard Form 1040 to the IRS, but you must also complete Schedule C form to detail your profit and loss statement. You will have to pay taxes on what the IRS deems as your profits through a convoluted process of paperwork and receipt-gathering.

Bookkeeping software and strategies can make this process a whole lot easier. On top of that, the IRS allows you to write off all manner of expenses on your taxes. 

Deducting Business Expenses

The list of IRS business deductions allows you to write off any “ordinary and necessary” business costs, which include anything from equipment to meals to utility bills to travel expenses. So save those receipts, and be sure to record them in some form of bookkeeping software.

You can deduct your business costs for travel and mileage, which can include airfare, hotel stays, rental cars, and travel meals. But if you use your vehicle for both personal and business reasons, the rules get much more strict. You can only write off specific business mileage on a ‘both business and personal’ vehicle, but the cost of a demonstrably business-only vehicle can be written off entirely.

A vehicle, laptop, or any other business purchase can only be written off if you use it exclusively for business purposes, so be careful not to deduct personal purchases as business costs. 

But you can also deduct your personal health insurance costs, as well as health insurance costs for your spouse and any other dependents. Health insurance deductions are unique in that you deduct them before calculating your Adjusted Gross Income (AGI). Most deductions are taken afterward.

The home office deduction is tempting for many sole proprietors, but be aware that the designated office must be used exclusively for business. If your “home office” also contains the bed you sleep in every night, that deduction may not hold up to the scrutiny of an IRS audit. 

Further, you have to conduct business in that home office regularly—you can’t take an office deduction on an empty or unused room. But the office does not have to be the place where most of your revenue is generated. If you operate a brick-and-mortar small business, you can still deduct a home office that is not located at your storefront. 

If you think your home office might qualify, take a good hard read of this 32-page set of IRS home office deduction guidelines to make sure you are in compliance with the reporting standards.

Self-Employment Tax

Anyone who runs their own business is responsible for paying the Self-Employment Tax, which is 15.3% of your income. This amount may seem unfair, but it’s the equivalent of the Social Security and Medicare taxes that traditional full-time employees pay. 

However, you can deduct 50% of your quarterly of your Social Security and Medicare contributions. Yes, you can take a tax deduction out of your taxes.

You might also qualify to lop off up to 20% under the 2018 Tax Cuts and Jobs Act. A sole proprietor can qualify as a “pass-through entity” under the new tax structure and can deduct up to 20% of business income from their income taxes.

How to Avoid an IRS Audit

Sole proprietors are more likely to be audited by the IRS because the agency is particularly sensitive to the possibility that personal expenses could be written off. But you still file personal and self-employment taxes together—you file personal income taxes on Form 1040 while determining your self-employment on a Schedule C – Profit or Loss from Business form in the same filing.

A reliable way to avoid an IRS audit is to use small business bookkeeping software to track your finances carefully. There are also apps to simplify your bookkeeping with features to create custom invoices, generate profit and loss reports, or track expenses automatically. Most importantly, a bookkeeping app can automatically create a tax summary.

Lendio’s software has pricing plans starting at $0, with customized plans for starting businesses, growing companies, and corporations. You can schedule a call for a free consultation. One of the best sole proprietor tax tips is to sign up for Lendio and get some of your taxes and bookkeeping to take care of themselves.

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The information provided in this post does not, and is not intended to, constitute tax advice; instead, all information, content, and materials available in this post are for general informational purposes only. Readers of this post should contact their tax professional to obtain advice with respect to any particular tax matter.