Deduction Categories for a Sole Proprietor

By Christine Varad

A sole proprietorship is just a business owned by a single individual. The earnings, expenses, profits and losses of a business need to be reported on the individual owner’s state and federal tax returns. The Internal Revenue Service provides a form, Schedule C, for reporting business-related income and deductions. The IRS also provides the sole proprietor with several categories of tax deductions related to running the business and being self-employed.

Operating Expenses

The IRS allows a sole proprietor to deduct operating expenses, the costs of doing business, on his individual tax return. Generally “ordinary expenses” and “necessary expenses” are tax deductible. Ordinary expenses are those costs commonly associated with doing business in a certain area of trade. Necessary expenses are the costs arising from anything that is helpful and appropriate to doing business, but need not be considered indispensable in day-to-day operations.

Administrative and Tax-Related Expenses

A sole proprietor can deduct the administrative expenses of his business, such as the cost of maintaining a home office and expenses arising from the business use of a car. The deductions associated with a home office may include mortgage interest, utilities and repairs on the home. The cost of trade or professional licensing and insurance are similarly deductible. Preparing a tax return and certain taxes paid out, in connection with doing business, to various federal, state, local and foreign taxation authorities may also be tax deductible.

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Self-Employment Expenses

Sole proprietors are generally considered self-employed and, as such, they must pay self-employment tax as well as income tax. The self employment tax is a Social Security and Medicare tax for those that work for themselves. However, a business owner can deduct any expenses related to being self-employed, such as the cost of buying health insurance and contributions to a retirement plan.

Intangible Expenses

Costs, including depreciation, arise from tangible and intangible sources. The cost of starting and organizing a business, leasing goods or property necessary to conduct business as well as travel and advertising expenses are all examples of tangible expenses. An intangible expense would include costs arising from things such as obtaining a business trademark, patent, copyrighting business related patterns or songs, and even the costs of maintaining a trade secret. Both tangible and intangible expenses are tax deductible.

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Depreciation in a Sole Proprietorship

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Common Sole Proprietorship Industries

Sole proprietorships are a popular business structure because they are simple to set up and have few state filing and tax requirements. Entrepreneurs create sole proprietorships for a variety of businesses ranging from construction to retail to professional services. In many states, there is no filing requirement to set up a sole proprietorship.

Trademark Amortization Rules

The Internal Revenue Service and the tax authorities in some states have specific rules about trademark amortization deductions. Section 197 of the Internal Revenue Code (IRC) allows the capitalized cost of a trademark to be amortized and then deducted from taxable income rather deducted as an ordinary business expense. Capital cost amortization is required if the trademark is part of a trade or business, or if it is otherwise used to generate revenue.

How to Open a Sole Proprietorship

More than 22 million people run sole proprietorships in the United States, making it the most popular form of American business. One reason for this popularity is that sole proprietorships are the simplest type of business to form and start operating. Formal business requirements for a sole proprietorship are minimal, and a sole proprietor has the option of transforming her business into a partnership, LLC or corporation later on.

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