Sole Proprietorship Business Deductions

By Jeff Franco J.D./M.A./M.B.A.

Despite the fact that a sole proprietorship isn’t treated as being a separate and distinct entity from its owner, the IRS still allows you as a sole proprietor to take advantage of the same business expense deductions that are available to other business entities, such as a corporation. However, many business deductions have specific requirements that you must satisfy before you can report them on a tax return, so it’s a good idea to familiarize yourself with some of the IRS rules.

Despite the fact that a sole proprietorship isn’t treated as being a separate and distinct entity from its owner, the IRS still allows you as a sole proprietor to take advantage of the same business expense deductions that are available to other business entities, such as a corporation. However, many business deductions have specific requirements that you must satisfy before you can report them on a tax return, so it’s a good idea to familiarize yourself with some of the IRS rules.

Employee and Contractor Pay

Sole proprietorships can hire employees and independent contractors and deduct all salary and contractor payments. For employees, however, the IRS requires that the wages you provide be reasonable in amount given an employee’s skill set and level of responsibility. For example, if you hire an engineer who has 15 years of experience, deducting a $150,000 annual salary isn’t unreasonable. In contrast, providing the same salary to a part-time office manager is probably unreasonable in the eyes of the IRS and may not be fully deductible.

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Office and Supplies

If your business requires office space, you can report a deduction for annual rent payments to the property owner and all utilities that aren’t included in the rent. Furthermore, you can also deduct the office supplies you purchase during the year, such as ink cartridges for printers, paper, pens, staplers and any other supplies that are necessary for the business.

Motor Vehicles and Travel

One of the more significant deductions you can take covers expenses that relate to acquiring, maintaining and operating vehicles that are used in the business. If you use a vehicle for both personal and business purposes, you can only deduct the expenses you incur for business use – calculated as the ratio of business miles to all miles driven. Deductible expenses include gas, oil, repairs, maintenance, tolls, parking, insurance and lease payments. For vehicles that you purchase, you can recover the cost through annual depreciation deductions or, if you use the vehicle at least 50 percent of the time for business and purchase it during the tax year, you can make an Internal Revenue Code §179 election and take a larger deduction than depreciation typically allows. As an alternative to deducting your actual vehicle expenses, you can always keep track of the miles you drive and calculate your deduction using the standard mileage rate.

Other Business Expenses

An exhaustive list of all possible business deductions for sole proprietors doesn’t exist; as long as an expense is ordinary – meaning that it’s the type of expense that similar businesses normally incur and necessary or helpful to your business, you can deduct it.

Taking Business Deductions

Since a sole proprietorship isn’t a separate legal entity, the IRS requires you to report all profit and losses from the business on a Schedule C attachment to your personal tax return. Schedule C is the form where you report all business deductions, as well as your business income, to calculate your net profit or loss. However, if the total of your business deductions is $5,000 or less, you can use the shorter Schedule C-EZ form instead.

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References

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Classifying Payments to Yourself in a Sole Proprietorship

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