What Your CPA Wants You to Know
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What Your CPA Wants You to Know
88. Throwback: New Business Owner? You're likely a Sole Proprietorship without knowing it!
THROWBACK EPISODE! OLDIE BUT GOODIE :)
If you started a business and didn't file any paperwork, what type of business are you??? Do you know???
The IRS will automatically classify your business as a sole proprietorship and that you will file the business income and expenses on Schedule C of your personal tax return. So not much will change except for your tax return!
If you filed an LLC, you can still be classified as a Sole Proprietorship. You will have some additional filing requirements for the state you filed the LLC in.
In this episode we discuss:
-Do you need an EIN for your sole proprietorship?
-What expenses can you deduct (i.e. save $$ in taxes)?
-How do you file your business taxes?
-What other filing requirements do sole proprietors have?
-Can you be an LLC and a sole proprietorship?
If you are new to owning a business, this episode is a perfect place to start educating yourself on paying taxes as a business owner!
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The confusion here is usually people file an LLC for their business and they think that that is their business tax entity and they are completely separate things. Welcome to what your CPA Wants you To Know a podcast for business owners and those planning to make the jump into entrepreneurship. If you're thinking, I've got a great business idea, but what's next? This podcast is for you.
Speaker 2:I'm Carson Sands.
Speaker 1:And I'm Taryn Sands, and together we started our CPA firm. We've grown exponentially over the past six years.
Speaker 2:I'm a CPA with over 10 years of experience helping people start and grow their businesses.
Speaker 1:And I'm an MBA with a specialization in marketing and entrepreneurship.
Speaker 2:Follow along as we share the ins and outs of running a business while keeping your family and sanity intact.
Speaker 1:And how to save tax dollars without breaking any IRS rules or triggering a painful audit.
Speaker 2:We're here to share everything your CPA wants you to know in a fun and easy to understand way. Let's get started.
Speaker 1:Let's do it. Today we are talking about sole proprietorships. It's a big word. If you have a small business that you just started and you really don't even know what tax entity you are, you're probably just a sole proprietorship. That is where most people start out and it is the easiest type of business to start First. Let's start by explaining what exactly is a sole proprietorship.
Speaker 2:I'm going to read the definition from our new business guide. A sole proprietorship is a business with one owner or husband and wife owners. The income made by a sole proprietorship is filed on Schedule C of the owner's personal tax return, which is their Form 1040,. Most new business owners choose to begin as a sole proprietorship and then switch to a different business entity when the business becomes more profitable.
Speaker 1:So I think it is important to say here that when you first start, you probably don't know that the IRS has four different tax entities to choose from. Know that the IRS has four different tax entities to choose from. Now, if you don't choose one, then you're automatically just going to be a sole proprietorship until you make a change.
Speaker 2:And you can go back to episode six the best tax entity to choose for your business. If you want to hear about all four types of business entities.
Speaker 1:Yes, that's going to go in much more detail about each one, why you would pick one over the other and how each of them are taxed, because it's just a tax entity to tell the IRS how they're going to tax income from that business. So one of the very first questions that we get about sole proprietorships is do you need an EIN for them?
Speaker 2:You don't have to have one. Whether or not you get one depends on a few factors. If you want to have a business bank account, then a lot of times they require that you have an EIN for your business. It's really easy to get one. But if you're just receiving a little bit of money on a 1099, technically you're a sole proprietor and you might not necessarily need a separate EIN for your business.
Speaker 1:So it's really just up to you. You can choose to get one if you just want to mask your social security number and just be operating under an EIN instead. But sole proprietors can use their social security number even to send out 1099s and things like that.
Speaker 2:Yes, taryn, hit the nail on the head. The other reason you would need an EIN besides for banking purposes, would be that you are going to issue 1099s to subcontractors or some other tax form, and you don't want to just issue those using your social security number, so the whole world has access to that. You could get a tax ID number, an EIN or an employer identification number and use that to put on all the 1099s that you send out to subcontractors.
Speaker 1:So you definitely do not need one if you're a sole proprietorship, Like you would need one for these other tax entities. So it's up to you. But they are very easy to get. I would just suggest getting one. You can get one on the IRS website in just a few minutes.
Speaker 2:So the next question we get a lot how does a sole proprietor file their taxes on Schedule C and what is the due date?
Speaker 1:So you touched on this a little bit earlier when you read that definition from our book. But a sole proprietorship is one of the easiest businesses to have because you just file that business income on your personal tax return. So you're basically just adding another form. It's called Schedule C and that's where you will put your income from the business and all of your expenses.
Speaker 2:And what is the due date for that?
Speaker 1:Since it's your personal tax return, the due date does not change. You still file that by April 15th every year. It is important to know, if you're using a CPA to prepare your tax return, that if you go from just a simple 1040 to adding a business, you should expect to pay a little bit more to have that business on your tax return because it requires more work.
Speaker 2:So the next question is what can you deduct?
Speaker 1:A great rule of thumb when you're trying to decide if something is deductible or not is anything that you need to generate the income that you're making. But we always get questions and it varies a lot. The IRS rules are very complicated, but I did want to read the list that's in our book so that you have a good idea of the things that are deductible, though with your specific business there may be more. So here's a list of deductible expenses Employee meals, advertising and marketing insurance, both business and health insurance for self-employed individuals, bank fees, business mileage on your car, depreciation, continuing education costs, home office expenses, interest, legal fees, accounting fees, moving expenses for the business, rent licenses, various taxes, business travel, phone and internet software. The list just goes on and on, but most businesses will have these things and they are deductible. This next question comes up a lot and it generally confuses a lot of people but can you be a sole proprietorship and an LLC?
Speaker 2:Yes, definitely. The LLC or limited liability company is a filing that businesses use in order to protect themselves from liability. It protects the personal assets of the owner in case the business gets sued for something that happens. In that case, ideally, if everything's working properly, only the business assets are up for grabs in a lawsuit and the personal assets of the owner are still safe. The LLC, if you're still a sole proprietorship, would still file on a Schedule C on your personal 1040.
Speaker 1:The confusion here is usually people file an LLC for their business and they think that that is their business tax entity and they are completely separate things. So if you want more information about LLCs and if you should file one for your business, we do have an entire episode about that and it is episode number nine.
Speaker 2:And just one more quick point on that. While your federal filing requirements don't necessarily change just because you filed for an LLC, your state filing requirements almost always change. They definitely do in our state of Texas and I know most of the other states that I work in. The same thing. You know you have a filing you have to do every year in order to maintain that LLC, but it's usually still much less complicated than filing a separate federal tax return is in the case that you were one of the other types of entities.
Speaker 1:This is a big question that we love to answer, and that is should you stay a sole proprietorship forever?
Speaker 2:Probably not. Hopefully, your business will grow to the point where you're making more than $50,000 in profit, in which case you're hitting that level where it makes sense to convert to an S-corp, so you can convert your LLC if you already have one, or, if you don't, you can file for an LLC and choose to be taxed as an S corporation.
Speaker 1:So that was a lot of information. But the answer to the question is that if your business starts making over $50,000 in profit you can see that right on your tax return then it's going to be worth it to convert it to an S corporation, which is a different type of entity. The reason you would do that is to save money in taxes.
Speaker 2:And, once again, episode six of the podcast talks about the different entities. S corp is one of those types of entities, so you can find out more by listening to that episode.
Speaker 1:At that point. If you're an S corp, then yes, you would just stay as an S corp. After that, you wouldn't need to convert to anything else. So one of the reasons that we love the S-Corp is that they do not pay self-employment taxes, but sole proprietorships do. So since today we're talking about sole proprietorships, it is important that you know what self-employment taxes are. So, carson, can you please explain what self-employment taxes are? So, carson, can you?
Speaker 2:please explain what self-employment taxes are. Unlike W-2 employees, who have Social Security and Medicare taxes withheld from their paycheck, a self-employed person doesn't have anybody withholding those taxes for them. Now IRS really doesn't want you to miss out on the joy of paying Social Security and Medicare tax, so they came up with self-employment tax, which is 15.3%. It's actually exactly equal to the amount of payroll tax that you pay if you're a W-2 employee, so that 15.3% tax is taxed on your profit from your business, and so that's your net income after you take all of your sales and you subtract all of your business. And so that's your net income after you take all of your sales and you subtract all of your expenses.
Speaker 1:Now it is very important to know that that tax is on top of the normal income tax that you already pay, so that's a lot of taxes.
Speaker 2:It can be really high. If you're in the 24% tax bracket, like so many people are, and you add in 15.3% for self-employment tax, you're looking at upwards of 39.3% tax total on the money that you're bringing in. And that's another reason it makes sense to look into the S-Corp whenever your profits are above $50,000.
Speaker 1:Now it is important especially hearing that super high number that you are setting aside money to pay those taxes. So if you just started or if you're getting yourself into a bind every single year and owing a lot of money, you need to make sure that you're looking at your profit and that you're setting aside a little bit each month so that you can pay those taxes those taxes.
Speaker 2:Your CPA should be able to tell you a pretty good rate that you should be setting aside to cover self-employment taxes and income taxes on your self-employed income.
Speaker 1:And that's going to be different for every single person. We can't just give you a blanket number to set aside and that would cover everyone, because your tax return is going to look different than everyone else's, you're going to be in a different tax bracket and your spouse might be making additional income, so there's a lot of variables. We can't just tell you set aside this much.
Speaker 2:Right. For example, if you're making $40,000 from your self-employed business on your Schedule C and you're not married, then your income tax will be very low, and so the amount you need to set aside is different than if, let's say, you're married and you're still making that $40,000, but your spouse makes $400,000 a year. Well then, you're going to need to set aside a lot more money to cover your tax bill.
Speaker 2:And at the very minimum, no matter what your profit is, you are going to be paying that 15.3% of self-employment taxes and then income tax of either 10, 12, 22, 24, 32, 35, or 37%.
Speaker 1:Fun stuff, we just deliver all. The best news on this podcast 37% Fun stuff, we just deliver all the best news on this podcast. Okay, some other exciting news that we need to talk about is if you have a sole proprietorship we already talked about saving that money and that you're going to file every single year on April 15th that's when you're going to pay those taxes Do you have to make estimated tax payments if you have a sole proprietorship?
Speaker 2:It's a really good idea. There's not necessarily a rule. I mean, I guess there is a loose rule that you have to pay in quarterly. You could be penalized slightly if you don't pay in quarterly estimated tax payments, but we always advise it, just because it's too easy for a business owner to set aside the money and then accidentally spend it on some really important business thing that came up. So, yes, pay in your estimated tax payments, and if you want the details of how much to pay, how to calculate what that number is and when those are due, listen to episode 23, where we talk about estimated taxes in detail.
Speaker 1:So the very last question that we get is are there any other filing requirements or paperwork or anything like that that you need to know about if you are a sole proprietorship?
Speaker 2:If you are a sole proprietorship that has filed for an LLC, then, yes, there's some additional filings that you'll need to do at the state level, but other than that, no, there's really nothing else special that you need to do for your sole proprietorship, except for include your Schedule C in your 1040 each year.
Speaker 1:And if you're just getting started, there's no paperwork that you need to file unless you're filing the LLC. Otherwise, the first year in business you'll just file that income on your 1040. That will alert the IRS that you have a sole proprietorship and that's really all that you have to do as far as paperwork goes is make sure you're filing that every single year on Schedule C of your 1040. So that wraps it up for today.
Speaker 1:I did want to mention, if you are just getting started in your sole proprietorship, we do have a new business guide that we referred to earlier. That has so much information that we talked about here in detail and also gives you some very important steps along the way. So if you want to hire someone, what would you do? How to do your bookkeeping, how to work with the CPA it's really packed with so much good information. Now, if you go to our website that link is in the show notes you can enter code podcast and that will give you a discount on our new business guide, which will knock it down to like 65 bucks. So you're getting so much information from a CPA for less than the cost of just one meeting.
Speaker 2:And if you want to hear from some people that used our new business guide, go back to episode 20 and listen to Nate and Sky from Olive Coffee Cart talk about how they use the new business guide to make the most boring part of their business really easy kind of like hitting the easy button.
Speaker 1:Yeah, that's such a great episode that shows how you can actually buy the guide and implement that in your business.
Speaker 2:That way, they can spend less time on accounting and more time making awesome coffee for people.
Speaker 1:Exactly so until next time.
Speaker 2:thank, you so much for listening to what your CPA.
Speaker 1:Wants you To Know. Podcast.
Speaker 2:This podcast is intended to provide accounting and tax information for educational purposes only. All tax situations are unique and should be handled with the assistance of a tax professional.