A sole proprietorship is a form of business which operates as the alter ego of the owner and is not a separate legal entity or a separate taxpayer. As such, the earnings or losses arising from the business activities of the sole proprietorship are attributed directly to the owner himself.
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A sole proprietorship reports business income and related business expenses on Schedule C of his personal income tax return. This includes gross sales, net returns and standard business expenses, such as rent, cost of goods sold, wages, supplies, utilities, depreciation, interest and advertising.
As with any business, a sole proprietorship's expenses may exceed its gross revenues, resulting in an operating loss. Although this is generally an undesirable outcome for the sole proprietor, the tax code provides the taxpayer with some form of relief.
A net operating loss from Schedule C can be applied against the sole proprietor taxpayer's other sources of income, creating a form of a tax shelter. This can be advantageous as it can reduce the overall taxable income of the sole proprietor and his total tax bill accordingly.
Unlike other forms of business, such as a corporation or partnership, once the sole proprietor timely files his complete and accurate individual tax return with Schedule C attached, whether it shows an income or loss, he has satisfied his income tax filing obligations with the IRS.