Many small businesses begin as sole proprietorships…and this comes with tax considerations. Here are seven things you should think about as you launch your business.

What is a sole proprietorship?

A sole proprietorship is the simplest business structure, where the owner reports business income and expenses on his/her own personal tax return. The owner is personally liable for all debts and obligations of the business.

7 key tax considerations for sole proprietors

1. Your income and expenses are reported on Schedule C of Form 1040- As a sole proprietor, you'll owe taxes on your business's net income, even if you don’t take any cash out. Business expenses directly lower your gross income rather than being treated as itemized deductions. If your business incurs losses, they can typically offset other income, but there are specific rules that apply to hobby losses, passive activity losses, and situations where you weren’t “at risk” so to speak.
2. You are liable for self-employment taxes- In 2024, self-employed taxpayers pay 15.3% in Social Security and Medicare taxes on net earnings, but only up to $168,600. For any earnings above that, you only pay the 2.9% Medicare tax.
3. You must pay estimated taxes on a quarterly basis- Sole proprietors owe estimated taxes as well. Any income that is not subject to withholding, like self-employment income, interest, dividends and rental income is subject to estimated taxes. Estimated taxes for 2024 are due April 15^th, June 17^th, September 16^th and January 15^th 2025.
4. You could be eligible for the 20% pass-through deduction- Essentially the 199A deduction, sometimes referred to as the 20% Pass Through Deduction, allows sole proprietors to take a deduction for up to 20% of their qualified business income (QBI), with some limits. This deduction lowers your taxable income, not your gross income. You can still take it even if you use the standard deduction instead of itemizing. Keep in mind, it's only available until 2025 unless extended by Congress.
5. You might qualify for health insurance and home office deductions- As a sole proprietor, you can deduct 100% of your health insurance costs as a business expense, meaning your medical insurance deduction is not limited by the rules for other medical expenses. Additionally, you may be able to deduct mortgage interest/rent, insurance, utilities, repairs, maintenance and depreciation if you work from a home office. Travel expenses from home to another location could also qualify for a deduction.
6. If you hire employees, you will have additional tax responsibilities- Bringing on employees? As a sole proprietor and employer, you will need to withhold taxes from employees’ paychecks (income tax, social security and Medicare), pay payroll taxes and submit payroll tax reports and annual tax forms to the IRS and state agencies.
7. You will want to consider setting up a qualified retirement plan- Contributions to a retirement plan are deductible when made and taxed when withdrawn. SEP and SIMPLE plans offer tax benefits with less paperwork, and if you don't set up a plan, you can still contribute to an IRA. Check out our blog, https://kahnlitwin.com/blogs/tax-blog/self-employed-secure-act-2-0-expands-your-retirement-saving-options

Recordkeeping considerations

It’s crucial to maintain thorough records of income and expenses. Your expenses in particular should be meticulously recorded, as you may qualify for tax breaks.