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Conducting business as a sole proprietor is one of the simplest forms of operation. It’s easy to start a business operated as a sole proprietorship and equally easy to discontinue.
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 purchase for each piece.
For equipment purchased in 2014, the IRS allows you to deduct up to $500,000 of the cost in the year you place the asset in service. For 2015, this amount is reduced to $25,000. This applies to used equipment as well. However, the IRS does not allow you to expense equipment that you purchased from a related party or equipment that you converted from personal use.
Making estimated tax payments
As a sole proprietor, the IRS requires you to make quarterly estimated tax payments. If you don’t, you may be subject to late-payment-of-tax penalties. The IRS requires you to make estimated tax payments if any of the following apply:
Having employees work for you requires some additional paperwork and recordkeeping. For each employee you must:
You may hire your spouse or children to work for you, but you must treat them as bona fide employees and pay them reasonably in order to take a deduction for their wages.
Home office deduction
The IRS allows self-employed taxpayers to claim a deduction for home-based business expenses if they meet certain requirements:
Home office calculations
There are two ways to calculate your home office deduction. The simplified method uses a standard deduction. If you maintain a qualifying home office, you may elect to deduct annually $5 per square foot of home office space up to 300 square feet, for a maximum deduction of up to $1,500. If you choose this method, depreciation is not allowed for a portion of your home; however, you can claim allowable mortgage interest, real estate taxes and casualty losses on the home as itemized deductions on Schedule A. These deductions need not be allocated between personal and business use, as is required under the regular method. Business expenses unrelated to the home, such as advertising, supplies and wages paid to employees are still fully deductible.
Otherwise, you may calculate your deduction using the actual expense method. 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 carpet.
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 nonbusiness portions of the home. The most accurate method of allocation is to divide the square footage of 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 rooms used for business by the total number of rooms.
The home office deduction is limited to the amount of net self-employment income prior to the home office deduction. Any disallowed home office deduction is carried forward to future years. See your tax professional for additional guidance.
Starting a retirement plan
As a self-employed taxpayer, the IRS treats you as the employer and employee. Generally, 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 that you can set up for your business. Some of the more common types are:
This is not an 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. Seek the advice of your tax professional before choosing the plan that is right for you.
This article contains general tax information for taxpayers. As each tax situation may be different, do not rely upon this information as your sole source of authority. Please seek professional advice for all tax situations.
© Copyright January 2015 – National Association of Tax Professionals
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