With less than a month to go before the tax filing deadline, taxpayers are steeling themselves for last-minute changes, checks, and balances.
One group of individuals in particular always tend to be groping in the dark when it comes to tax return season. Given the fluidity of their situation, sole proprietors often face many challenges while preparing their tax documents.
Sure, the perks of being your boss are fantastic, but the downsides can be pretty nasty if you’re not well-versed in the taxation side of things. Below, we explore some common problems sole proprietors can face while filing their tax returns and how to overcome them. Read on to know more about the mistakes you should avoid and work around them.
Who are Sole Proprietors?
Before we dive into what they could potentially do wrong, let’s first look into who precisely sole proprietors are and what filing as a sole proprietor entails.
To begin with, sole proprietorships are one of the most common business structures in the US, owing to their flexible structure and potential for easy establishment.
Essentially, there is no difference between the individual and the business for taxation purposes: The IRS considers the business owner a legal business entity and an individual.
Individuals can receive the entirety of their business profits but are also equally liable for all debt and expenses incurred by the business. Business income passes through the business to the business owner, who then reports on their tax returns. This drastically reduces paperwork but can often complicate matters if figures are not declared correctly.
Additionally, sole proprietors are likely to be individuals whose professions allow them to either work remotely or require traveling to customers.
This entity is typically devoid of the traditional ‘brick-and-mortar’ structure. Typical professions that may fall under sole proprietorship include:
Home healthcare service providers
Freelancers (content creators, photographers, web developers, etc.)
Business consultants or public speakers
What Problems Do Sole Proprietors Face?
Sole proprietors have to be extra careful about handling tax obligations, especially since the consequences could be an IRS audit or simply leaving money on the table.
Common issues include:
1. High tax bills and low refunds
Most self-employed taxpayers tend to lose out on sizable refunds and the opportunity to lower their tax bills. This is simply because sole proprietors are unaware of the deductible expenses they can claim against their income.
Running one’s own business can be challenging enough, so having to pay hefty tax bills shouldn’t be another burden that sole proprietors take on.
It is advisable to keep accurate and detailed records of all expenditures and maintain separate checkbooks for business and individual purchases. Doing so can simplify providing proof of deductible expenses and significantly lower one’s taxable income.
Common deductible expenses include:
Start-up costs: includes operational costs and expenses incurred to get the business up and running, such as repairs, advertising, and purchasing supplies.
Transport and automobile costs: money spent on keeping a vehicle roadworthy, especially helpful if one’s business is dependent on traveling by cars, such as bakery and parcel-delivery businesses.
Insurance premiums: expenses incurred while covering oneself and one’s workspace from possible losses.
Legal and professional fees: money spent on hiring financial and legal consultants for their expertise in the field.
Educational fees:particularly useful for business owners that have attended classes that foster professional development in their field.
2. Increased risk of penalty charges
No taxpayer wants trouble with the law, especially not with the IRS regarding taxation and discrepancies in the amounts filed.
Sole proprietors are exposed to a higher risk of paying penalty fees since other taxes mustbe paid over and above income and personal taxes.
Being aware of these taxes and their payment deadlines is critical to keeping everything kosher in tax documentation.
Sole proprietors should watch out for the following taxes:
Federal and State estimated taxes:sole proprietors are responsible for estimating their annual tax bill for all income earned and making quarterly payments to the IRS.
Federal and State income taxes: sole proprietors must accurately declare all business profits and losses and any other personal income. Business owners should be aware that their tax bracket is decided based on both personal and business income and must be prepared to pay taxes accordingly.
Self-employment taxes: sole proprietors needn’t wait for traditional employers to withhold portions of their income for FICA contributions. Instead, they should be making these Medicare and Social Service contributions while paying their taxes.
3. Delays in refunds & problems with incomplete tax documents
It’s no secret that backlogs inundate the IRS, but processing times are worsened by a lack of ‘open and shut cases. In addition, going back and forth with taxpayers about errors in their forms, missing documents, and invalid proofs makes life difficult for both parties.
To ensure that you present a textbook tax filing case, you must submit all required forms and documents and triple-check every information you’ve provided—right down to crossing your I’s and dotting your T’s. Silly errors and forgetfulness can delay refunds, which can be avoided by being well-prepared.
Sole proprietors must submit the following documents:
Schedule SE: must be submitted if your business earned more than $400 worth of revenue
Form 1040, Schedule C: provides details about business income, expenses, and inventory.
Being the owner of a small business is an exciting experience. You are the captain of your ship, and you have complete control over when and how you set sail.
However, as the April 15 tax deadline approaches, your confidence may fade, given the unfamiliarity with US tax laws. As a result, filing your taxes as an Indian who owns a sole proprietorship in the United States might be stressful.
This article will show you how to avoid such eight blunders while filing as a sole proprietor and do your taxes swiftly.
Who is a Sole Proprietor?
A sole proprietor is an individual who owns and operates their own business. For instance, you are a sole proprietor if you work as a freelance writer. However, you must obtain the necessary licenses and permits by industry standards. Your business income is your income, and you are responsible for paying taxes.
Eight Pitfalls to Avoid While Filing as a Sole Proprietor
If you are a sole proprietor, you’ll need Form 1040 to pay your taxes and declare your earnings on Schedule C. Self-filing taxes might be intimidating. However, it’s much more daunting if you file as a sole proprietor.
We have compiled a list of eight common blunders sole proprietors make while filing taxes:
1) Ignoring quarterly tax payments
In the United States, businesses must pay estimated taxes every quarter. The IRS will penalize you if you wait until April 15 to pay the taxes in full.
As a result, it is more prudent to account for your profit and loss and pay your taxes every quarter. You can withhold a portion of your business income as taxes each month and send the IRS a quarterly tax payment.
2) Failure to meet tax deadlines
If you fail to pay your taxes on time, you will be subject to a penalty of 5% of your monthly taxable income. Furthermore, the IRS has the authority to fine you up to 25% of your total tax bill.
They can also charge you a 0.5% late fee for each month you don’t pay after the deadline. Request a personal tax extension if you are unable to meet the deadline. However, you must pay a portion of the outstanding balance by the initial date.
3) Cheating on your tax bills
According to an IRS survey of 2001, sole entrepreneurs underreported $68.5 billion in business income. As a result, you must provide an accurate tax estimate while filing as a sole proprietor.
If you earned more than $600 in the current fiscal year, the company that paid you is obligated to send you a 1099-MISC form and your paycheck.
They also provide a copy of the same to the Internal Revenue Service. As a result, you must accurately disclose your earnings to the IRS. Even if you don’t receive the 1099-MISC from the client or if it’s incomplete, make sure it’s updated before the tax deadline.
4) Failing to claim home office deductions
You are eligible for home office deductions while filing as a sole proprietor if you work from home. You can work from home in an office or a designated place.
Many business owners are hesitant to take advantage of this tax break. However, if you file as a sole proprietor, you can claim this deduction and save money on your taxes.
The IRS uses two formulas to compute the deduction amount: standard and simplified. Keep track of electricity bills, repairs, and other expenses for the standard deduction.
You can also claim $5 per square foot using the simplified formula. Therefore, the most you can receive for a 300 square foot home office is $1500.
5) Failing to claim deductions for business gifts
The gifts you offer your clients for branding purposes can help you save money on taxes. A $25 per person business gift deduction is allowed under the tax laws.
As a result, if you claimed $1000 in this category, including receipts and proof that the gifts were given to the required number of persons, you’re up for a rebate.
6) Confusing equipment and supply deductions
Business supplies include pens, paper, printer ink, notepads, etc. Equipment includes computers, software, and office furniture. Supplies should be reported on Schedule C, and equipment should be listed on a separate form 4562.
The IRS may not consider a deduction if you record supplies as equipment or vice versa. Furthermore, you can deduct the total cost of the equipment in one go. Alternatively, you might claim a portion of it each year.
7) Failure to track your expenses
If you keep track of every dollar you spend on your business, you can claim some of it as a deduction from the IRS. Hence, keep receipts and documentation to back them up.
For example, you can deduct not only your phone bills and travel insurance premiums but also web hosting, online courses, educational materials, and so on.
Thus, instead of scrambling to find receipts right before April, make it a practice to file them and keep track of your expenses.
8) Registering your firm as a wrong entity
If you end up paying more taxes as a sole proprietor, it’s wiser to change your business entity to an S-corporation. Similarly, if it lowers your tax burden, you can choose an LLC or C-corporation. Always consult your CPA or tax professional before making a decision.
Hence, by filing as a sole proprietor in the United States, you can take advantage of over 28 tax deductions. You can also put your tax savings to good use and go for business expansion.
If the IRS comes knocking on your door, prepare the necessary receipts and documentation to back them up. If you correct the aforementioned errors, you may soon find yourself staring at a sizable return.
On 27th March 2020, the US President Donald Trump had signed the CARES (Coronavirus Aid, Relief, and Economic Security) Act into law. This CARES Act also led to the initiation of a $2 billion Stimulus package which can be said as the largest emergency relief bill passed in the history of America so far.
A part of this Stimulus package includes cash payment to the eligible Americans which has been termed as “Stimulus Check” by common people and as “Economic Impact Payment” by the IRS. Technically, Stimulus checks is an advanced tax credit meant to offset an individual’s federal income taxes for 2020.
So, now there are numerous queries related to the eligibility of obtaining Stimulus checks popping up in the minds of the Americans.
Who is eligible to obtain Stimulus checks?
The basic eligibility for obtaining Stimulus checks from the US Government can be summarized below.
You must be a US citizen or a US National or a US resident alien.
You must not have been claimed as a dependent on the tax return of someone else.
Your Adjusted Gross Income (AGI) in 2018 or 2019 should be below the threshold for your filing status.
You should have filed a tax return for the year 2018, 2019 or should have Social Security Benefit Statement, or Form SSA-1099, or Form RRB-1099 or Social Security Equivalent Benefit Statement.
The Stimulus Check payment which would be obtained as per the AGI threshold can be summarized as below.
a.A single individual or married but filing tax returns separately
If your Adjusted Gross Income (AGI) is below $75,000 then the Stimulus Check received would be an amount of $1200.
In case of your Adjusted Gross Income (AGI) being more than $75,000, the amount received as Stimulus Check would be reduced by $5 for every $100 increase in the AGI above $75,000.
You would also receive an additional $500 for each qualifying child who is below the age of 17 years.
In case your AGI is above $99,000 and no qualifying children are claimed, there would be no Stimulus Check obtained.
b.Married couples filing tax returns jointly
If you are married and filing tax jointly with an AGI which is less than $150,000 the Stimulus Check received would be $2400.
In case the AGI is more than $150,000 the Stimulus Check would be reduced by $5 for every $100 increase in the AGI above $150,000.
You can also obtain an additional $500 for each qualifying child who is below the age of 17 years.
In case the AGI is above $198,000 and no qualifying children are claimed, there would be no Stimulus Check obtained.
c.Individuals filing tax returns as the “Head of Household”
1. In this case, if the AGI is less than $112,500 the Stimulus Check received would be $1200.
2. In case the AGI lies in between $112500 and $136500 the Stimulus Check would be reduced by $5 for every $100 increase in the AGI above $112,500.
3. You would obtain an additional $500 for each qualifying child who is below the age of 17 years.
4. In case the AGI is above $136,500 and no qualifying children are claimed, there would be no Stimulus Check obtained.
Qualifying criteria for a dependent to receive the Stimulus payment
You must be claiming your dependents in case of your tax returns.
Your dependents must be below the age of 17 years.
Your dependents should be a US national or a US citizen or a US resident alien.
They must be related to you either by blood, marriage or by adoption.
Your dependents must have lived with you for at least half of the year.
Moreover, some more additional information related to the qualifying criteria of dependents can be noted below.
Your dependent must have a valid Social Security Number (SSN) to qualify for the receipt of Stimulus payment.
There is no limit on the number of dependents who can be eligible for obtaining the additional $500 in Stimulus check from a particular household.
In case you are claiming your child as a dependent and your child also files his tax then he would be qualifying for an additional $500 payment as your dependent. He would not be considered eligible for his Stimulus payment.
In case you have not filed your 2019 tax return and your dependent was 16 years while filing 2018 returns, then he is eligible to obtain the $500 Stimulus payment.
Hence, with the Stimulus Checks being an effective method to overcome the financial crisis caused by COVID-19 it is advisable to file your 2019 tax returns soon if you have not done so yet.