Tax Treatments
When computing taxes, all profit and losses of the business are added to any other income received by the owner on the owner's Form 1040, Individual Federal Income Tax Return. The profits or losses from the business are normally reported on Schedule C, Form 1040, Profit or Loss from Business, as part of that process.
If the business had a profit, the owner will have to pay income taxes (federal and/or state) at the same rate as the owners personal tax rate (corporate rates are usually higher). If the business had a loss, that is subtracted from any other income the owner (and spouse if filing jointly) earned that year.
For example, if you had a $20,000 business loss reported on your Schedule C and earned $80,000 at another job, then your Adjusted Gross Income would be $60,000 ($80,000-$20,000). This would reduce your personal tax liability.
If the business buys capital equipment (has a projected life of more than one year), such as a compressor, trailer or vehicle, they must be reported separately - from a tax point of view - as depreciable items. You are allowed to deduct the entire amount of the purchase (up to a certain amount) or deduct a little bit of the purchase price over several years. This is advantageous if you figure your profits are going to be more in future years and thus could use the deductions more in the future than in the current year.
Depreciable equipment has to be entered on a depreciation schedule, which flows to your Schedule C, which flows to your personal Form 1040. It should be noted that when you sell or dispose of a piece of equipment, that also has to be reported. If it is sold at a loss (the form figures in how much you paid for it, how much you sold it for and how much you already deducted against income), it is reported on Schedule D, Form 1040, Capital Gains and Losses.
Capital losses are then subtracted from any capital gains you may have received (from other investments, businesses or otherwise). If the result is a loss, you are allowed to subtract up to $3,000 a year against your other income before figured tax liability. Any excess can be carried over to future years until it is all used up.
Self-Employment Tax
The first year a businessperson turns a profit, they become responsible for self-employment taxes (also called payroll taxes or Social Security Taxes), if your net profit was $400 or more. These currently run up to 15.3 percent of the NET PROFIT that the sole proprietorship reported on Schedule C. They include two components:
- A 12.4 percent tax for old age, survivors, and disability insurance (OASDI - which most people know as Social Security), which has a dollar cap that is adjusted each year. For instance, for 2021, only the first $142,800 is assessed this tax.
- A 2.9 percent tax for Medicare, which has no dollar cap.
A sole proprietorship is not subject to Federal Unemployment Tax (FUTA), unless he has employees. The FUTA tax is 6.2 percent of the first $7,000 of each employee's salary. There may also be a state employment tax (which can be taken as a credit on the federal FUTA).
Self-Employment earnings and taxes are reported on Schedule SE, Form 1040, Self-Employment Tax which flows through to page 2 of the individual's personal Form 1040. The sole proprietor can then deduct one-half of the self-employment tax as a deduction against income on page 1 of the Form 1040.
As you can see, getting to know your tax treatments can be quite a learning curve, so it is worth the cost of a tax professional specializing in business to sort them all out and help educate you on best practices to limit you liabilities.