aren’t separate from you, the business owner, and are considered to belong to you, the owner. In addition, all income and expenses (including your salary) are listed on Schedule C, Profit or Loss From Business or Schedule C-EZ. The net profit or loss is transferred to your Form 1040 Individual income tax return. No separate tax rate schedule applies to sole proprietorships, and you are not subject to any special business income taxes. However, keep in mind that as a sole proprietorship you are still responsible for city, state and federal self-employment taxes on your firm’s net profits, as well as for any payroll taxes for employees, which must be paid quarterly.
Planning to incorporate? Tax experts recommend a Subchapter S Corporation status. An S Corporation operates as a regular corporation with shareholders, a board of directors and officers, but differs with regard to tax liability.
“It [S Corporation status] offers corporate liability protection, but income taxes are paid at the shareholder level instead of at the corporate level, as they are with a C Corp,” explains Piehl. “And if your business experiences a loss in its first year, you may be able to pass that loss through to your personal income tax return.”
Jacqueline Bell, owner of J.M. Bell & Associates L.L.C. in Indianapolis, operated her human resources and hotel management training and consulting firm part-time for 10 years before leaving her job as general manager for Courtyard By Marriott in Indianapolis to become a full-time entrepreneur last year. Today, she has a client roster of seven, and provides training in such areas as diversity, customer service, sexual-harassment prevention and team building for $1,200 to $1,500 per day. She chose a limited liability structure for specific reasons.
“It’s easier to manage my business finances and tax reporting responsibilities to the IRS, local and state governments,” says Bell, 49. “[The L.L.C. structure] afforded me flexibility. With the issues I deal with, it opens me up to litigation, but as an L.L.C., I have personal liability protection.”
No matter what structure you choose, if you have employees, you will be responsible for collecting employee withholding tax (check with your city and state tax office for requirements). The IRS cautions against spending these funds because it is money owed to the government. And you could find yourself subject to a penalty if you use this money to pay bills because of cash constraints and later find yourself short when tax payments are due. To simplify your payroll process, use a payroll service. If you have more than one employee, you can outsource payroll to companies like ADP, Paychecks or Staples for as little as $20 to $30 a month.
Tax experts say most small business owners are unaware of breaks that can help them lower their tax bills. Consider these tax deductions you may have overlooked:
- You can deduct business purchases in the first year you incur them, up to $19,000, instead of taking deductions based on yearly depreciations.
- If you’re a home-based business, you may qualify to file