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Thomas G. Post
"The Texas Tax Man"
Certified Public Accountant
Home | Sales Tax | Payroll | ACA | Entrepreneurs | Sole Proprietors

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Tomball, TX 77375
P O Box 1757
Tomball, TX 77377-1757
Phone - 281-351-2688

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Sole Proprietors

(Detailed Discussion)

A sole proprietorship is an unincorporated business owned by one person. This type of entity should have a separate bank account.

The sole proprietorship reports its income statement (profit & loss) on Schedule C, which becomes part of the taxpayers FORM 1040.

The income lines on Schedule C include:

    1. Gross receipts of sales
    2. Returns and allowances
    3. Cost of goods sold
    4. Other income: i.e. interest, refund, credits

The expense lines on Schedule C include:

    1. Advertising
    2. Bad debts from sales or services
    3. Car and truck expenses
    4. Commissions and fess
    5. Depletion
    6. Depreciation and section 179 expense
    7. Employee benefit programs
    8. Insurance (other than health)
    9. Interest
      1. Mortgage (paid to banks, etc.
      2. Other
    10. Legal and professional services
    11. Office expense
    12. Pension & profit-sharing plans
    13. Rent or lease
      1. Vehicles, machinery and equipment
      2. Other business property

(21) Repairs and maintenance

(22) Supplies

(23) Taxes and licenses

(24) Travel, meals, & entertainment

      1. Travel
      2. Meals and entertainment

(25) Utilities

(26) Wages

(26) Other expenses; i.e. tolls, parking, telephone, etc.

A sole proprietor is allowed to deduct all ordinary and necessary business expenses (Internal Revenue Code Section 162).

If an ordinary and necessary business expense does not fall into one of the items on lines 8 thru 26. Simply include it on the schedule, which compromises the total of line 27. "other expenses".

Meals and entertainment expenses are limited to 50% of the amount incurred. Some meals and entertainment expenses are not subject to this 50% disallowance. The most notable exception is meals provided for the "convenience of the employer".

Sole Proprietorships often qualify for "Office in Home" expense – see FORM 8829.

Depreciation – Separate Section

For tax and accounting purposes assets are treated different form expenses. Expenses are deducted in the year incurred where as assets are written off over their life expectancy (IRS provides tables). An asset, generally speaking, is something that is expected to last longer than the tax year. Examples include office equipment, furniture, computers, automobiles, etc.

A sole proprietor is allowed the elect to write off up $108,000.00 of tangible assets in one tax year in 2006 (Internal Revenue Code Section 179).

AUTOMOBILE EXPENSE

Automobile expense is often a significant ordinary and necessary expense for a sole proprietorship. In year 2006, the IRS allows a deduction equal to 44.5 cents per business mile driven. In order to claim this deduction, the taxpayer needs to maintain a record of business miles driven during the year. An all-inclusive logbook is the best evidence possible.

Where the complete log is not available some form of sampling is allowed. For example a taxpayer might keep a log of twelve weeks during the year (one each month) and use it the extrapolate mileage for the year for.

    1. Business
    2. Commuting
    3. Other
    4. Total

For item "d" you need to know mileage at the beginning and end of the year.

In addition to Schedule C Sole Proprietorship is required to file Schedule SE for self-employment tax.

FORM 1040ES

A sole proprietorship is required to pay both income tax and self-employment taxes on a quarterly bases as follows: 4/15, 6/15, 9/15, and 1/15. Generally speaking the expected income and self-employment tax for the quarter must be paid bye these dates.

An annualization of the tax for the year is done based on:

Due date Amount due

1st three months 4/15 25 %

1st five months 6/15 50 %

1st eight months 9/15 75 %

Twelve months 1/15 100 %

In lieu of annualization of the current year a taxpayer may estimate his tax for the current year based on the immediately preceding year. E.g. for 2000, a taxpayer can use his/her 1999 liability.

One of the hardest concepts to teach business people and professionals is "estimated tax payment requirements". Self-employment tax is roughly 14.1% of net income (profit) on Schedule C. If a taxpayer is in the lowest income tax bracket (15%) his/her combined income and self-employment rate equals 29.1%. Allowing for the benefit of personal exemptions and standard or itemized deductions (if they haven’t already been used against other income) and effective tax rate of 25% of net bottom line of the business income may be reasonable.

The farmer and fisherman have some rules for estimated tax payments. If at least 2/3rds of a farmers or fishermen gross income in 2005 or 2006 was from farming or fishing. The required annual payment is 66 2/3% of the tax shown on the 2006 return or 100% of the tax shown on the 2005 return. Estimated taxes can be made in one installment of January 16th of 2006, or the taxpayer can make no estimated payment if the return is filed and the tax paid by March 1, 2006.

If a taxpayer is in the 28% income tax bracket (say his/her spouse earns a salary of $45,000.00), the effective tax rate for income and self-employment tax is 42.1% (28% _ 14.1%). Maybe that’s why the concept is so hard to teach. The lesson is very important because late payment of income and self-employment tax is another form of an unauthorized loan from the IRS. Remember the IRS rates and procedures (despite their friendliness campaign) are much tougher that the banks. In fact they are tougher than most "loan sharks".

Sole Proprietorships can do tax planning to reduce their taxes such as:

    1. IRS Section 179 first year write offs.
    2. Employing their children
    3. Set up retirement plans
    4. Claiming office in home expenses
    5. Maximizing automobile expense

Also, a sole proprietor is never subject to the second level of tax that can apply to a regular "C" Corporation.

Finally, many of the much ballyhooed, self-made "millionaires" got that way through a sole proprietorship.

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