Schedule C For Sole Proprietors
Copyright 2010 by Morris Rosenthal - - contact info
Planning A New Business
Copyright 2010 by Morris Rosenthal
All Rights Reserved
Business Deductions and Expenses for Self Employed 1040 Filers
Warning: These pages are not intended as professional advice. They are presented "as is", reader beware!
After 17 years as a sole proprietor, I've filled out Schedule C and read through the instructions enough times that I'm starting to talk like the IRS, or at least like the Congressional sub-committee that writes the tax code. Some of the deductions and expenses a sole proprietor can to take on Schedule C are obvious and require no explanation, others get tricky. Some also come as a surprise to people filing business taxes as a sole proprietor for the first time, such as searching for where to deduct your health insurance (if you have any). Good luck on that, self employed people filing as sole proprietors in the U.S. don't get to claim a business deduction for health insurance. No, it's not fair, it's just the way it is.
Schedule C is where you need to start in order to complete your 1040 filing. All of the other forms you fill out are in some way related to the Schedule C, which determines the profit or loss for you business, ie, your gross income, along with an other wages or investment earning you may have on the year. As you fill out the form, you may find you need to complete a couple other forms first, like Form 4562 where you expense or depreciate property you've purchased for the business during the year, and Form 8829 for deducting the cost of doing business in your home. But there's no point jumping ahead to those forms before you have to, and you may find that some of the expenses you planned to take there are actually Schedule C deductions. One minor bit of IRS schizophrenia you should be aware of is that car and truck expenses for the business can be taken in one of two places, on the back of Schedule C below the inventory adjustments or on the back of Form 4562, if you have section 179 property deductions or depreciation that year.
Many of the Schedule C deductions are related to employee expenses. If you don't have employees, these will remain blank. Remember, one key difference between being a sole proprietor and the corporate forms of business is as a sole proprietor, you cannot take employee deductions for yourself under any circumstance. In some cases, such as with an IRA or other pensions plan deductions, you will have an opportunity to take them later on the face of the 1040 form, but they will be worth much less at that point. The Schedule C sets your gross profit for the year, and the very first thing the IRS does with that profit is to take 15.3% of it for social security and medicare. If you earn over $100,000, you start getting close to the cut-off (which goes up every year) where the government stops taking the social security part, and only takes the medicare part. Congratulations if you make it that far. A little known fact is that sole proprietors reporting profits between about $33,000 and $108,000 (single filer) pay the highest marginal tax rates, period. Wall Street bankers, Bill Gates, Warren Buffet, they all pay a lower tax rate on their gross income than the self employed individual earning below the social security cut-off.
Some sole proprietors see a business as a way to live a more lavish lifestyle with pre-tax dollars. To some extent you can do this. If you love to travel and the industry you work in gives you a legitimate reason to travel (conventions, training, visiting suppliers, travel journalism, etc), you can write those expenses off, which means paying for them with pre-tax dollars. Some sole proprietors take advantage of the vehicle deductions by taking all of the expenses for a car or truck as business expenses but using it for personal activity. This may be more common with married couples where there's another car in the family to make everything look on the up-and-up. Meal expenses are another area where people get a little creative with what constitutes a legitimate business lunch as opposed to meeting a friend.
But for the main part, filing as a sole proprietor actually maximizes taxes for most people, as opposed to filing as an S Corporation. But it's easier, doesn't require as much bookkeeping, and it appeals to the procrastinator in us all who says, "I'll incorporate when my gross is a little higher and I can really benefit from taking a salary and not paying social security on the rest of the income." For the last fifteen years, I've been saying this, and the only upside is that I've helped fund my parents social security payments.
Planning A New Business | Estimating Business Taxes | Schedule C Deductions | Car Expenses | Freelancer and Contractor Payments | Section 179 Depreciation and Form 4562 | Employee Benefits and Pension Costs | Professional Services, Business Taxes and Fees | Hotel and Travel Expenses | Deducting Food and Entertainment | Inventory and Cost of Goods Sold | Sole Proprietor Statistics | Home Office Deductions | Self Employment Tax | The Self Employed Sole Proprietor