What You Need to Know About Taxes as a Sole Proprietor

Many entrepreneurs start their businesses as sole proprietors. It’s an easy way to dip your toe in the water of being self-employed, but it’s important to meet your tax obligations. Here are some things to be aware of:

1. Schedule C. Throughout the year, maintain good records of your business income and expenses separately from your personal finances. At the end of the year, you’ll report your business results on Schedule C of your personal Form 1040. Business-related expenses are deductible against the gross income of your business and are not reported as itemized deductions. Any losses are generally deductible against your other income unless they’re hobby losses, passive income losses, or losses in activities in which you weren’t at risk. Business losses may also be limited if they exceed business income by more than $250,000.
2. Qualified Business Income Deduction. Qualified Business Income (QBI) is the net amount of qualified income, gain, deductions, and losses that are included in the taxable income of a qualified trade or business, including sole proprietorships. If your business generates QBI, you may be able to deduct up to 20%, depending on whether you meet certain income thresholds. More information from the IRS website can be found by clicking here.
3. Home Office Deductions. If you use part of your home for business, you may be able to deduct that use on your Schedule C. To qualify as a deduction, your home must be the principal place of your business and have a specific area used regularly and exclusively for business. If the area is used for both business and personal purposes, it does not meet the criteria for “exclusive use”. For instance, if your home office is also a playroom for your toddler, it is not used exclusively for business. More information about the home office deduction can be found in IRS Publication 587.
4. Self-Employment Taxes. If you’ve worked for someone else, you know that 7.65% of your gross income is withheld for FICA and Medicare. What you may not know is that your employer matches that amount for a total 15.3% contribution toward Social Security and Medicare. As a self-employed individual, you are responsible for paying that entire 15.3% on your self-employed net earnings up to the Social Security Taxable Wage Base of $147,000 (2022). Above that threshold, Medicare taxes continue at a rate of 2.9%, with an additional .9% Medicare tax for self-employment income in excess of $200,000 (single taxpayers), $250,000 (married taxpayers filing jointly) or $125,000 (married taxpayers filing separately). Self-employment tax is in addition to income tax, with half of your self-employment tax deductible against income.
5. Health Insurance Costs. Unlike the personal income tax limitation that only allows medical expenses to be deductible if they exceed 7.5% of your adjusted gross income, 100% of your health insurance premiums paid through your business can be deducted as a business expense.
6. Quarterly Estimated Tax Payments. As a self-employed individual, you’re not receiving a regular paycheck with tax withholding, so you’re responsible for making quarterly estimated tax payments. For 2022, these are due April 18, June 15, September 15, and January 17, 2023.
7. Maintain Good Records. We’ll say it again – it’s imperative to keep your business finances separate from your personal finances. Record all income and expenses and retain backup documentation such as invoices and receipts. Pay special attention to the business use of your automobile, business-related meal & entertainment expenses, and home office expenses because they’re subject to special recordkeeping requirements.
8. Employees. If your business hires employees, you’ll need a separate federal taxpayer identification number and will need to withhold and pay payroll taxes. More information is available in IRS Publication 15, Employer’s Tax Guide.

Questions? We’ve got answers – contact your Mize relationship manager.