Sole Proprietorship

In General: This is the simplest form of business. A sole proprietorship is not a separate entity itself. Rather, a sole proprietor directly owns the business and is directly responsible for its debts. Unlimited Personal Liability for Loss: In a sole proprietorship, the owner is personally liable for the company, thus placing his or her entire personal assets and wealth at risk. If an owner is married, that owner puts the community property at risk as well. Management and Control: The owner (sole proprietor) has total management and control over the company. However, the price for total management and control is that the owner is at risk for personal liability incurred through the acts of the owner’s agents or employees. No Formalities: With the exception of complying with any applicable licensing requirements, there are no formalities required of a sole proprietorship.   Note, however, where the business is conducted under a name which does not show the owner’s surname or implies the existence of additional owners, California, for example, requires that the owner file a fictitious business name statement and publish notice. Transferability: The owner can sell the business as he or she pleases. Duration: The sole proprietorship remains in existence for as long as the owner is willing or able to stay in business.

Sole Proprietor Rules:

Business Expenses

Business expenses that are ordinary and/or necessary for your business may be deductible. Ordinary means it is a common expenses in your field. Necessary means it is helpful and appropriate for your business. You will need to keep your canceled check and your invoice as proof.

Typical Expenses

Advertising: You do not have to prove it increased your business.

Car & Truck: you are required to keep a written record of your mileage. Standard mileage rate usually yields a higher deduction. In addition to the mileage rate, you also get the cost of parking and tolls. You cannot include commuting mileage.

Commission & fees: Expenses for services performed by non-employees.

Interest: Related to business loans including credit card interest if credit card is used 100% for business.

Legal & professional services: Includes fees charged by accountant, lawyers and tax preparers.

Office: If you do not meet the requirement for Office-In-Home, you can still deduct your office expenses. This includes supplies, equipment telephone and furniture.

Rent or lease: Includes property vehicle machinery or equipment rental. Vehicle rental deduction may be reduced. Rent-to-own contracts are sales not leases.

Repairs & maintenance: Does not increase the value of the asset. Includes supplies, labor and sales tax.

Taxes & Licenses: Includes real estate and personal property tax, employers share of FICA taxes, Federal and State unemployment taxes and Federal highway use tax. Does not include sales tax.

Travel: Business trips that require you to stay overnight are deductible. Expenses include hotel, travel, parking and tips. Keep cost of meals separate.

Meals and entertainment: Includes meals while traveling. Entertainment expenses must be directly related to business. You must discuss business before, during or after the meal or entertainment. Keep the receipt and write on the back who you met with and a brief description of the business discussed. Deduction is limited to 50%.

Utilities: Can deduct the business long-distance phone calls and the cost of a second line into your house if this line is used for business only.

Wages: Wages paid to employees. Do not count what you paid yourself.

Depreciation: If you purchase business assets with a useful life greater than one year, their expense is deducted over a period of years, defined by the IRS. This annual deduction is called depreciation. The year you purchase a new asset you may be able to deduct the total amount of it. This depends on the type of your business, if it had a profit, the type of asset purchased and its cost.

Inventory: Items purchased to be resold are considered inventory. Your inventory records are kept separate from your other expenses. You need to get a value of your inventory at the beginning of the year and again at the end of the year. You also need to keep track of the goods purchased during the year. There are several ways to value your inventory. The most common used is “First In First Out” method., referred to as “FIFO.” This method assumes that the first purchased items are the first to be sold. The value of your inventory would be the lower of your cost or market value.

Other: To list the type and amount of expenses that did not fit in the other categories. For more information, see IRS pub 334.

 

Employee or Independent Contractor?

Many business owners like to classify all their hired help as independent contractors. To classify them as employees requires close adherence to IRS rules for withholding and paying payroll taxes. It is also more expensive. If your worker is an independent contractor, the only paperwork required is a Form 1099-Misc to be sent to the IRS and a copy to be sent to your worker. Therefore, there is a major temptation to overuse this method.

However , not every worker can be classified as an independent contractor. IRS has been actively auditing employers to make sure they use the correct classification. they have a 90% success rate of reclassifying workers as employees.

If you previously paid a worker as an independent contractor and the IRS rules against you, it will be very costly.

You become liable for employment taxes that should have been withheld from the worker’s pay such as FICA, Federal and State Income Taxes.

You become liable for employers’ share of FICA taxes.

You become liable for penalties and interest for failure to pay these taxes and for failure to file payroll taxes.

Common-Law Rules

IRS has a checklist to determine the correct classification of worker. A “yes” answer to any question below, may convince an IRS auditor that a worker is an employee.

1. Is the worker required to comply with instructions about when, where and how the work is done?

2. Does the worker need to be trained?

3. Are the services provided by the worker an integral part of business operations?

4. Must the services be rendered personally?

5. Is the worker not responsible for hiring, paying, or supervising assistants?

6. Is there a continuing relationship between the worker and the “employer?”

7. Are working hours set by the “employer”?

8. Is the worker required to devote full-time efforts to “employer’s” business?

9. Is work performed at the place of business of the company, or at specific place set by the company?

10. Does “employer” direct sequence in which work must be done”

11. Are regular oral and written reports required to be submitted by the worker?

12. Is the method of payment hourly, weekly, or monthly (as opposed to commission or by the job)?

13. Are business and or traveling expenses reimbursed?

14. Does the company furnish tools and materials used by the worker?

15. Has worker failed to invest in equipment or facilities used to provide the services (such as an office)?

16. Does the worker have no risk of real economic loss?

17. Does the worker perform services exclusively for the company rather than working for a number of companies at the same time?

18. Does the worker in fact not make his/her services regularly available to the general public?

19. Is the worker subject to discharge without “employer” penalty even if job specifications are met?

20. Can the worker terminate his/her relationship without incurring a liability for failure to complete the job?

Strategies

The right to control the worker is the key issue. As much independence as possible should be given to the worker in areas such as hours worked, supervision on the job, and the location where the work is to be performed. The worker should be required to provide his/her own tools, supplies, etc.

You should have a contract with the worker and a written agreement that he/she is an independent contractor. Also the worker should send you a bill for services rendered.

If you are unsure how to classify a particular worker the IRS will make the determination for you. You will need to file Form SS-8 with their District Director of Internal Revenue.

For more information see IRS Pub 937.

 

Office-in-Home

Many people set up an office in their home. Some use this office to complete work for their employer after hours. For some their employer does not provide another work location, so they need the office to do all their paperwork. Still, others may be self-employed and, therefore, have no other location to do their office work. But they all want to deduct their expenses. However, you must meet specific requirements to deduct your expenses for the business use of your home. Even if you meet these requirements, your deductible expenses are limited.

In order to quality for the deduction you must pass the following Use Tests:

The area used for business must be used regularly and exclusively. Regular use means it is used on a continuing basis not just occasionally. Exclusive use means that the area you set up for your office is used for business purposes only.

There are two exceptions to the exclusive test:

1) Storage of inventory or product samples if your business is wholesale or retail.
2) Day-Care services provided in your home on a regular basis.
 

This office must be your principal place of business. This is based on the relative importance of the activities performed at each business location and the amount of time spent at each location. You will need to compare the relative importance of the activities performed at each location. This will differ based on the type of business you have.

If your business requires that you meet with clients at their location or that you deliver goods or services to a customer, the place where that contact occurs is considered where the most important activities are performed.

Planning services or doing accounting at your office is not the most important activity per IRS.

There are two exceptions to this rule:

1) You maintain a separate, freestanding structure on your property and use it regularly and exclusively for your business.

2) You use your office to meet with customers on a regular basis.

Deductible Expenses for Office in Home

	Mortgage Interest
	Real estate taxes
	House insurance
	Home repairs, maintenance
	Utilities
	Rent
	Depreciation

These expenses are deducted according to the business percentage of the home. To get the percentage divide the area used exclusively for the business by the total area of your home. For Day-care providers you divide the area of your home used for business by the total area of your home, then multiply it by the percentage of time devoted to providing the day care services.

Mortgage interest and real estate taxes can create a loss on your Schedule C. The other expenses are limited to the net income of your business. Any unused deductions can be carried forward to the following year.

Any repairs or improvements made to your office will be 100% deductible.

To depreciate your home you need to know when you purchased your home, how much you paid for it (less land value), and any improvements made to your home.

For more information see IRS Pub. 587.