Let’s dive into some of the more frequently asked questions surrounding sole proprietorships:
Who is a sole proprietor?
A sole proprietor can be an independent contractor or an individual that owns and operates a business and generates self-employment income. The business may have been formed by filing for a “DBA” (doing business as) or by forming a legal entity known as “SMLLC” (single-member limited liability company). However, not all sole proprietorships were formed in an official manner. A sole proprietor can be anyone that earns money working for themselves, whether it’s a side-hustle or a full-time gig, as long as the activity is conducted with a profit motive.
How is a sole proprietor taxed?
A sole proprietor reports business income and expense activity annually on their Form 1040 by completing and attaching a Schedule C, Profit or Loss from Business. An individual who conducts a business for-profit is allowed to deduct any expenses that are considered ordinary and necessary in carrying on the activities of the trade or business. If expenses exceed income, the net loss is deductible against other income.
If your business generates a net profit, net income would be subject to both Federal and State income taxes, in addition to self-employment tax, which is an additional 12.3 percent.
How are sole proprietors paid?
Questions frequently arise as to how a sole proprietor pays themselves and whether or not payroll needs to be setup so they can be paid in the form of “wages.” If you are a one-man show and have no other employees working for you, then the answer is no. In this case, a sole proprietor would not take a wage, but simply take “cash draws” from their business at any time as cash flow permits. Any cash draws are considered a “return of capital” to the owner and are not a deducible business expense.
Contact Melissa S. Howell, CPA, Principal at Tronconi Segarra & Associates LLP, at 716.633.1373 or mhowell@tsacpa.com for more information.
