Conducting business as a sole proprietor is one of the simplest forms of operation. It’s easy to start a business operated as a sole proprietorship and equally easy to discontinue.
We also have an organizer (pdf file) that is aimed at Business Entities. This would include sole proprietors as well as partnerships and corporations. If you would like one, email us one and we will send it to you.
• If you plan on hiring employees, you will need to obtain an employer identification number (EIN) by filing Form SS-4, Application for Employer Identification Number, with the Internal Revenue Service. If you do not hire employees, you may use your social security number for filing purposes.
• Open a separate checking account for your business. It will be easier to track your deductible expenses if they are not commingled with your personal expenses.
• If you incurred expenses prior to opening your business, keep them separate from your other expenses. Special tax treatment applies to startup expenses. These expenses include:
* A survey for potential markets, products, or labor; advertisements for the opening of your business; salaries and wages for training new employees; and travel and other necessary costs for securing prospective distributors, suppliers, or customers.
Equipment that you purchase for your business is generally depreciated over its class life. In most cases, this is either five or seven years. It is important to keep accurate records of the cost of your equipment and the date of purchase for each piece.
For equipment purchased, the IRS allows you to deduct up to $250,000 for 2009 ($134,000 for 2010) of the cost in the year you place the asset in service. This applies to used equipment as well. However, the IRS does not allow you to expense equipment that you purchased from a related party or equipment that you converted from personal use.
Paying Estimated Tax Payments
As a sole proprietor, the IRS requires you to make quarterly estimated tax payments or you may be subject to late-payment-of-tax penalties. The IRS requires you to make estimated tax payments if any of the following apply:
• The total tax shown on your return, less the amount you paid through withholding (if you were also a wage earner) is more than $1,000.
• You expect your withholding and credits to be less than the smaller of:
* 90% of the tax shown on your current return; or
* 100% of the tax shown on your prior year’s return, 110% if adjusted gross income from prior year exceeds $150,000 ($75,000 for
married filing separate). Your prior year’s return must cover a full 12 months.
• Estimated tax payments are generally due on April 15, June 15, September 15, and January 15.
Having employees work for you requires some additional paperwork and recordkeeping. For each employee you must:
• Obtain a valid social security number.
• Have each employee fill out Form W-4, Employee’s Withholding Allowance Certificate.
• Have each employee fill out Form I-9, Employment Eligibility Verification.
You may hire your spouse or children to work for you, but you must treat them as bona fide employees and pay them reasonably in order for you to take a deduction for their wages.
Home Office Deduction
The IRS allows self-employed taxpayers to claim a deduction for home-based business expenses if they meet certain requirements:
• They must use the home office regularly and exclusively:
* As the principal place of business for a trade or business.
* As a place to meet with clients, patients, or customers in the course of the trade or business; or in connection with the taxpayer’s trade or business, if the location is in a separate structure not attached to the
* Note: Day care businesses are exempt from the “regular and exclusive” requirement.
• The IRS may allow a deduction for inventory storage if the product is regularly sold to others and there is no other fixed location available for the business.
Home Office Calculations
• When making home office calculations, consider direct and indirect expenses.
• Direct expenses are those that pertain exclusively to the home office, such as painting the walls or installing new carpet.
• Indirect expenses are those that pertain to the entire residence, such as rent, mortgage interest, taxes, insurance, repairs, utilities, casualty losses, and depreciation.
• Allocate indirect expenses between the business and nonbusiness portions of the home. The most accurate method of allocation is to divide the square footage of the office by the total amount of usable space in the home. If rooms are of approximately equal size, you can divide the number of rooms used for business by the total number of rooms.
* With a day care business, multiply this business percentage by the fraction obtained by dividing the number of hours the home is used for business by the total number of hours in the year (8,760 hours except in leap years).
• Once these figures are known, multiply the indirect expenses by the business percentage in order to apply the limitations.
Home Office Limitations
The amount of expenses you can deduct is subject to specific limitations and ordering provisions.
• Base the overall limitation on your net income from your business. This is the net income on Schedule C without the home office deduction.
• If there is a loss, the IRS does not allow a home office deduction. When there is a net loss, carry expenses forward to future years when there is net income.
• The IRS allows three deductions in full regardless of the net income limitation. They are allowed under other code sections and may create a Schedule C loss. You must claim these in full before using any other home office expenses:
* Mortgage interest
* Real estate taxes
* Casualty or theft losses
• Once the otherwise deductible expenses have reduced net income, you can deduct the other home office business expenses.
• If net income remains at that point, you can deduct home office depreciation.
• Anytime net income reaches zero, carry forward the balance of the home office expenses.
• If you go out of business before using these carry forward amounts, they are lost.
Starting a Retirement Plan
As a self-employed taxpayer, the IRS treats you as the employer and employee. If you start a retirement plan and make contributions for
yourself, you must make contributions for all your employees. There are several types of retirement plans you can set up for your business. Some of the more common types are:
• A Simplified Employee Pension (SEP). You have until the due date of your return (plus extensions) to set up and make contributions to
• A Savings Incentive Match Plan for Employees (SIMPLE). This type of plan must initially be set up by October 1, with contributions allowed up until the due date of your return (plus extensions).
• SIMPLE 401(k) plan. This plan is a cash or deferred arrangement allowing employees to make pre-tax salary deferrals.
• Keogh plan.
This is not an all-inclusive list of eligible retirement plans, nor is it intended to provide details on each plan and the requirements that apply to each plan. As with all retirement plans, it is necessary to seek
the advice of your tax professional before choosing the plan that is right for you.
This brochure contains general tax information for taxpayers.
As each tax situation may be different, do not rely upon this
information as your sole source of authority. Please seek
professional advice for all tax situations.
#863 – © Copyright May 2010
National Association of Tax Professionals
PO Box 8002
Appleton, WI 54912-8002