Small Business Tax Rules for Sole-Proprietorships

Sole proprietorships fall under special small business tax rules. The business income and activities can impact the owner's personal tax liability because it is an unincorporated business and a sole proprietorship. It's important to know a few basic rules to maximize your tax deductions and to owe less in taxes.

Husband and Wife Sole Proprietorships

You and your spouse are eligible for a "qualified joint venture", which means you can file your small business tax returns as a sole proprietorship even though two people own the business. The only stipulation is that you have to file a joint tax return. The other option is to choose one owner and then make both of you employees of the business. Doing so will split the income between the both of you, which may work to reduce your overall tax liability. Pay children a reasonable salary, and you can further spread the income from the business.

Home Office Expenses

You may be one of the many sole proprietors who work from home in order to save money. You're allowed business deductions for your home office, including:

  • Property taxes
  • Mortgage interest
  • Rent
  • Utilities
  • Improvement and repairs

Measure the square footage of the home office, and make sure that you use it exclusively for business. Divide that number over your home or apartment's total square footage to determine the percent (in square feet) that your home office occupies. Use that percentage to determine how much you can claim against your business income, by multiplying the percent and total payments made for eligible expenses. You're also allowed to carry these expenses forward and apply them in the future.

Income Categories

There are many kinds of income that you need to report as a sole proprietorship. In addition to client and customer payments, you generally have to report these as well:

  • Real Estate Rents (owners of hotels and similar businesses)
  • Bartering for Property or Services (income is based on fair market value)
  • Personal Property Rents (if you rent cars, equipment and so on)
  • Canceled Debt (include the canceled or forgiven amount as income unless it was a gift or bequest)
  • Interest and Dividend Income (should be related to ordinary course of business)

These are all forms of business income that you must account for on your small business tax return. Even if you earn any of these on a part-time basis or you consider it as a one-time income source, you have to report it on your tax return.

Auto Expenses

Many sole proprietors use their car for personal and business use. Some lease or purchase a car to use exclusively for business, especially if employees use the vehicles. Specific rules apply for these deductions, but in general you can deduct:

  • Fuel costs
  • Repairs
  • Maintenance
  • Depreciation
  • Lease payments

You have to keep an account on your end of travel costs associated with your business when your car is used for both business and personal activities. Keep all receipts for at least 7 years.

Small business tax rules are ever changing, and a good tax filing software will keep you up to date with changes in the laws. Hiring a small business tax accountant when you can afford to will also help you to understand tax rules for sole proprietorships.

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