Even those who earn academic degrees in business usually graduate with little knowledge about how to run a one-person operation. It’s no secret why that’s the case.
Universities strongly emphasize corporate finance in all their business-related majors, like marketing, management, accounting, and finance. So, what if you are the proud holder of a diploma but want to become a sole proprietor? You’re left having to do a lot of on the job learning. And when it comes to subjects like writing mission statements, advertising on a budget, and tax planning for the self-employed, you can end up making some pretty costly mistakes before getting it right. What should be the first item on your agenda? Taxes, of course. Here’s a quick guide to tax planning for those who run sole proprietorships, who face all sorts of unique challenges, like quarterly reporting, resisting the urge to incorporate, and keeping accurate books.
A common mistake new owners make is to set up the businesses as a corporation or limited liability partnership. Before taking this major step, consider the many benefits of staying small and filling out a simple Schedule C tax form along with your normal personal return each year. In addition to hefty fees and added bookkeeping requirements that go along with becoming an Inc. or an LLC, you will get a number of benefits. But most of those advantages don’t do much good for you if you’re still new, small, and doing okay as a sole proprietor. If you want the liability protection against lawsuits that seek your personal assets as compensation, simply take out a liability insurance policy rather than complicate the organizational structure of your business.
Automate the Record Keeping Process
Decades ago, record keeping was a major hassle for sole proprietors. Now, with the addition of specialty software for small businesses, it’s a breeze. Consider hiring a technical professional to install a system for you, and consult with a local CPA about what might be the best choices for your company. Try to automate the entire record keeping process, including financial statements, vendor invoices, individual expense accounts, etc.
Put Your Children on the Payroll
If you have children who can help with any of your routine tasks, from office cleaning to answering phones, put them on your payroll and keep their annual income below the $6,000 threshold. That way, every penny they earn will be shielded by the standard deduction on their own tax returns. They’ll owe nothing. You’ll get a legitimate expense write off directly from your Schedule C income. Be careful to give your children legitimate, company-related tasks. Otherwise, the IRS could disallow the deduction.
Deduct Your Personal Medical Insurance Expense
One of the biggest expense deductions most sole proprietors have is their medical coverage. The policy can be in your name, it doesn’t have to be in the name of the business. Plus, it can cover you, your children, your spouse, and any long-term care premiums. If you make your living as a sole proprietor, this deduction alone can save you thousands of dollars in self-employment tax.