To some, having their own business and being their own boss is the dream of a lifetime. When deciding to start a business, one of the first questions is what type of business structure should I use? Some entrepreneurs decide to be a sole proprietor. In fact, some say more women own sole proprietorships.

As a sole proprietor, you would report net income or loss from your business on your personal income tax return. However, there are several important rules that you should be aware of:

1. For income tax purposes, you will report your income and expenses on Schedule C of your Form 1040. The net income will be taxable to you regardless of whether you withdraw cash from the business. Your business expenses will be deductible against gross income and not as an itemized deduction subject to the 2 percent of adjusted gross income floor. If you have any losses, the losses will generally be deductible against your other income, subject to special rules relating to hobby losses, passive activity losses and losses in activities in which you were not “at risk.”

2. If you will be working from an office in your home, performing management or administrative tasks from a home office, or storing product samples or inventory at home, you may be entitled to deduct an allocable portion of certain of the costs of maintaining your home. And, if you have a home office, you may be able to convert nondeductible commuting expenses (of going from your residence to another work location) into deductible transportation expenses.

3. You will also be required to pay self-employment taxes at a rate of 15.3 percent on your net earnings from self-employment of up to $106,800 for 2010, and at a rate of 2.9 percent on the excess. (The maximum amount will be reduced by any non-self-employment wages you earn.) One-half of your self-employment taxes will be deductible as a trade or business expense (that is, as a deduction against gross income, not subject to the limits that apply to itemized deductions).

4. You will be allowed to deduct 100 percent of your health insurance costs as a trade or business expense. This means your deduction for medical care insurance won’t be limited by the normal 7.5 percent of AGI floor on itemized medical expenses.

5. Your income won’t be subject to withholding tax. However, you will be required to pay estimated taxes quarterly. We can work with you to minimize the amount of your estimated tax payments while avoiding any underpayment penalty.

6. You will have to maintain complete records of your income and expenses. In particular, you should pay attention to recording your expenses in order to be able to take the full amount of the deductions to which you are entitled. Certain types of expenses, such as automobile, travel, entertainment, meals and home office expenses, are subject to special record keeping requirements or limitations on their deductibility and require special attention. Personal expenses should not be co-mingled with business expenses.

7. If you hire any employees, you will have to get a taxpayer identification number and will have to withhold and pay in various payroll taxes. Employing younger family members can have tax benefits. You may turn some of your high-taxed income into low-taxed income by paying some of your business earnings to your child as wages for services performed by him or her. These wages are not subject to FICA tax if the child is under age 18. In addition, FUTA tax does not apply to wages paid to your child until the child is 21. If the business has a retirement plan, the child may also qualify for a contribution based on his or her wages.

8. You should consider establishing a qualified retirement plan. The advantage of a qualified retirement plan is that amounts contributed to the plan are deductible at the time of the contribution and aren’t taken into income until the amounts are withdrawn. Because of the complexities of ordinary qualified retirement plans, you might consider a simplified employee pension (SEP) plan, which requires less paperwork. Another type of plan available to sole proprietors that offers tax advantages with fewer restrictions and administrative requirements than a qualified plan, is a savings incentive match plan for employees; i.e., a SIMPLE plan. If you don’t establish a retirement plan, you may still be able to make a contribution to an IRA.

If you would like any additional information regarding the tax aspects of owing or starting your own business, or if you need assistance in satisfying any of the reporting or record keeping requirements, do give us a call.

This article provides general information and may not apply to your particular situation. In addition, this article does not offer legal or tax advice. The Internal Revenue Service recently issued regulations that require written advice regarding tax matters to meet very detailed and comprehensive requirements before it can be relied upon by a taxpayer to avoid penalties that might apply if the tax benefits or results discussed in this article are disallowed. Compliance with these rigorous standards and requirements exceeds the scope of this article. Consequently, the analysis and advice contained in this article regarding federal tax matters is not intended to be used, and may not be relied upon by you or anyone else, for the purpose of avoiding any federal tax penalty.

		Connie L. Berg cofounded Godfrey Wise Berg, CPAs and Advisors, LLC in 1995 with Godfrey after 26 years of experience as an office professional in a variety of diverse business arenas. She currently serves as business manager and director of human resources and marketing. D. Craig Godfrey, firm managing partner of Godfrey Wise Berg, CPAs and Advisors, LLC (GWB), has over 20 years of experience in taxation. Godfrey has a diverse client base and provides a wide range of services specializing in the areas of individual and business taxation.