Conducting business as a sole proprietor is one of the simplest form of operation. It's easy to start a business and just as easy to discontinue one.

Getting Started

• If you plan on hiring employees, you will need to obtain an employer identification number (EIN) by filling a Form SS-4, Application for Employer Identification Number, with the Internal Revenue Service. If you do not hire employees, you may use your social security number for filling purposes.
• Open separate Checking account for you business. It will be easier to track your deductible expenses commingled with your personal expenses.
• If you incurred expenses prior to opening your business, keep them separate from your other expenses. These costs include
  • A survey for potential markets, products, or labor; advertising for the opening of your business; salaries and wages for training new employees; and travel and other necessary costs for securing prospective distributors, suppliers, or customers.

Purchasing Equipment

Equipment that you purchase for your business is generally depreciated over its class life. In most cases, this is either five or seven years. It is important to keep accurate records of the cost of your equipment and the date of the purchase for each piece.

For equipment purchased in 2004 or later, the IRS allows you to deduct up to $102,000 of the cost in the year that you place the asset in service. This applies to used equipment as well. How ever, the IRS does not allow to expense equipment that you purchased from a related party or equipment that you converted from personal use.

Paying Estimated Tax Payments

As a Sole Proprietor, the IRS requires you to make quarterly estimated tax payments so that you will not be subject to late-payment-of-tax penalties. The IRS requires you to make estimated tax payments if any of the following apply:

• The total tax shown on your return , less the amount you paid through withholding (if you were also a wage earner) is more than $1,000.
• You expect your withholdings and credits to be less than smaller of:
  • 90% of the tax shown on your current return; or
  • 100% of the tax shown on your prior year's return. Your prior year's return must cover a full 12 months
• Estimated tax payments are generally due on April 15, June 15, September 15, and January 15.

Hiring Employees

Having employees work for you requires some additional paperwork and record keeping. For each employee you must:

• Obtain a valid social security number.
• Have each employee fill out Form W-4, Employee's Withholding Allowance Certificate.
• Have each employee fill out Form I-9 Employment Eligibility Verification

You many hire your spouse or children to work for you, but you must treat them as bona fide employees and pay them reasonably in order for you to take a deduction for their wages.

Home Office Deduction

The IRS allows self-employed taxpayers to claim deductions for home-based business expenses if they meet certain requirements:

• They must use the home office regularly and exclusively:
  • As the principal place of business for a trade or business
  • As a place to meet with clients, patients, or customers in the course of the trade or business; or in connection with the taxpayer's trade or business, if the location is in a separate structure not attached to the dwelling unit.

*Note : Day care businesses are exempt for the “regular and exclusive” requirement.

• The IRS may allow a deduction for inventory storage if the product is regularly sold to others and there is no other fixed location available for the business.

Calculations

• When making home office calculations, consider direct and indirect expenses.
• Direct expenses are those that pertain exclusively to the home office, such as painting the walls or installing new carpeting.
• Indirect expenses are those that pertain to the entire residence, such as rent, mortgage interest, taxes, insurance, repairs, utilities, casualty losses, and depreciation.
• Allocate indirect expenses between the business and non-business portions of the home. The most accurate method of allocation is to divide the square footage or the office by the total amount of usable space in the home. If rooms are of approximately equal size, you can divide the number of the rooms used for business by the total number of rooms.
  • With a day care business, multiply this business percentage by the fraction obtained by dividing the number of hours the home is used for business by the total number of hours in the year (8,760 hours except leap years).
• Once these figures are known, multiply the indirect expenses by the business percentage in order to apply the limitations.

Limitations

The amount of expenses you can deduct is subject to specific limitations and ordering provisions

• Bases the overall limitation on your net income from your business. This is the net income on Schedule C without the home office deduction.
• If there is a loss, The IRS does not allow a deduction. When there is net income, carry expenses forward to future years.
• The IRS allows three deductions in full regardless of the net income limitation. They are allowed under other code sections and may create a Schedule C loss. Your must claim these in full before using any other expenses:
  • Mortgage interest
  • Real estate taxes
  • Casualty or theft loses
• Once the otherwise deductible expenses have reduced net income, you can deduct the other business expenses.
• If net income remains at that point, you can deduct depreciation
• Anytime net income reaches zero, carry forward the balance of the expenses.
• If you go out of business before using these amounts, they are lost.

Starting a Retirement Plan

As a self-employed taxpayer, the IRS treats you as the employer and employee. If you start a retirement plan and make contributions for yourself, you must make contributions for all your employees. There are several types of retirement plans you can set up for your business. Some of the more common types are:

• A Simplified Employee Pension (SEP). You have until the due date of your return (plus extensions) to set up and make contributions to the plan.
• A Savings Incentive Match Plan for Employees (SIMPLE)> this type of plan must initially be set up by October 1, with contributions allowed up until the due date of your return (plus extensions).
• SIMPLE 401 (k) plan. This plan is cash or deferred arrangement allowing employees to make pre-tax salary deferrals.
• Keogh plan

As with all retirement plans, it is necessary to seek the advice of your tax professional before choosing the plan that is right for you. This is not all-inclusive list of eligible retirement plans, nor is it intended to provide details on each plan and the requirements that apply to each plan.

This brochure contains general information for taxpayers. As each tax situation may be different, this information should not me relied upon as your sole source of authority. Please seek professional advice for all tax situations.

#863 - © Copyright 2004

National Association of Tax Professionals

P.O. Box 8002

Appleton, WI 54912-8002

www.natptax.com