The Advantages of Sole Proprietorship Taxation

By Mark Kennan

A sole proprietorship is one of the less formal ways of running your business. You generally don't have any forms to fill out, and you operate under your own name. Your business doesn't have a separate legal existence from you as a person, meaning that your income and expenses appear on your income tax return, which has several advantages.

Convenience

As a sole proprietor, you report your business income on your personal income tax return, which is convenient because you only have to file one return. You do have to fill out Schedule C, however, which lists your income and expenses; your net sole proprietorship income flows onto your individual Form 1040 return. If you incorporated your business, you will need to file a separate tax return for the company, which increases the time and expense of tax filing.

Potential Lower Rates

Income from your sole proprietorship is taxed at your individual income tax rate, which may be lower than the corporate tax rates. For example, if the corporate tax bracket is 39 percent and your individual income rate is 28 percent, you'll save on the tax difference. Besides the potentially lower tax rates, you'll also avoid the double taxation that affects corporations. Corporate income from a C Corporation is taxed in the year it's earned on the corporate return and then taxed a second time when the income is distributed to the owners. With a sole proprietorship, you only pay individual income taxes on it once -- when you earn it.

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Umbrella Effect

If you have losses in your sole proprietorship for the year, you can use these losses to offset other income. For example, assume that your sole proprietorship has a $10,000 loss for the year. If you work a second job as an employee that pays you a salary of $40,000, you can use that $10,000 to reduce your other taxable income to $30,000. If you incorporated your business, the company's losses would be stuck with the company and could only be used when the company had future profits.

Net Loss Uses

If you have a loss from your sole proprietorship but don't have any other income to offset, you're not out of luck. Instead, you can carry it back for the prior two years or carry forward the loss for the next 20 years to offset your future gains. For example, say you have a $10,000 loss in the first year and no other income to offset. When you make a profit of $90,000 in the second year, you can carry that loss forward to bring your taxable income down to $80,000 in the second year.

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Tax Consequences of Converting a C-Corp to an S-Corp
 

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Sole Proprietorship & Capital Gains

Sole proprietorships are businesses owned by one person. Instead of reporting the income, gains and losses on a separate return, a sole proprietor includes his business’s annual fiscal activity on his personal tax return. A sole proprietor should include any capital gains the business might earn on his personal return. If you are a sole proprietor, you should consider consulting a certified public accountant or attorney when filing your returns.

Do I Need to Pay Taxes if I Do Not Make Revenue As a Sole Proprietor?

Sole proprietors carry on business in their own names, without partners or shareholders -- it's the simplest form of business entity. As a sole proprietor, you still must register your fictitious business name with the appropriate local government agency and file an annual tax return with the IRS and your state, if applicable. Sole proprietors pay income taxes on net income as individuals -- the business does not file a separate tax return.

Net Operating Loss for a Sole Proprietorship

It isn’t uncommon for sole proprietors to report losses in some years, which are the result of incurring business expenses that exceed total revenue. You may be able to use these losses to offset some of the other income reported on your tax return. However, if after combining your sole proprietorship losses with your other income the result is still a loss, you may have a net operating loss, or NOL, that you can deduct from the taxable income you report in different tax years.

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