Tax and Statistics: Tax benefits to forming a Sole Proprietorship

During the peak of the global pandemic in April 2020, former U.S. President Trump with the assistance of the Department of Treasury and the Small Business Administration (SBA) signed into law a $2 trillion Coronavirus Aid, Relief, and Economic Security Act, known as the CARES Act. The aid provided by the federal government gave small businesses, and self-employed individuals an opportunity to secure financial stability in the midst of one of the biggest U.S. economic downfalls since the Great Depression in 1933.

The swift intervention from the federal government meant that those who are registered as self-employed and self proprietors could secure benefits provided by the CARES Act, the Business Loan Program, or the Paycheck Protection Program. 18 months down the line, and a global pandemic still threatening the stability of the U.S. economy, how has taxation in regards to sole proprietors changed over the last year and a half. This website provides a thorough run-through on the basics of how individuals can start a sole proprietorship in their home state.

What is a sole proprietorship?
In legal terms, a sole proprietorship is viewed as an unincorporated business that is considered to be a low-risk and low-profit business. More so, there is no distinction between the business owner and the sole proprietorship.

How are sole proprietorships taxed?
The Internal Revenue Services (IRS) have eased the taxation for sole proprietorships, allowing owners and entrepreneurs to file income or losses as a personal income tax return. In this event, the business registered as a sole proprietorship itself is not taxed, and the IRS has coined this as ‘pass-through' taxation.

How do I estimate the tax for a sole proprietorship?
Owners of sole proprietorships are responsible to save and allocate enough money to pay annual or quarter taxes. Because these business owners do not have an employer that withholds any income tax, entrepreneurs must monitor quarterly allocations for the annual tax season.

It's good to consider that tax rates for personal income tax and various forms of business change are state-specific. Considerations for local and municipal taxes should be examined.

Do I file self-employment tax if I operate a sole proprietorship?
Seeing as sole proprietorships are considered as low-profit businesses, individuals should still contribute to Social Security and Medicare schemes. The government has eased the process of this taxation, coining it as "self-employment taxes" that are paid towards social security and medical aid schemes.

A review of self-employment taxes from the last few years revealed that self-employment tax was roughly 15.3% on the first $84,900 of income. For any amount above and over the initial $84,900 a 2.9% tax rate will come into effect.

To return, it's clear that sole proprietors file most of their annual taxation under self-employment taxes, and should consider the annual changes when it comes to tax rates throughout the states.

When should you incorporate your sole proprietorship?
There will come a time when your small business exceeds expectations, and the business will need to become incorporated to comply with local and federal laws and tax regulations. The larger the profits of a business, the easier it can be to incorporate your sole proprietorship. More so, businesses that are incorporated and registered as a corporation will enjoy better tax benefits, as corporation tax currently stands at 15%.

Business owners who are working towards harvesting more profits, and allocating more profits towards the business will see this as most beneficial for long-term financial security.

Incorporating a sole proprietorship will cut your annual tax bill, but additional regulations and changes will come into immediate effect once your business is registered as a corporation. The Really Useful Information Company (TRUiC) shares an abundance of information regarding sole proprietors.

Final take
As one of the easiest forms of business to register and operate, sole proprietorships house plenty of tax benefits for low-income and low-risk business ventures.  Finally, sole proprietorship owners and entrepreneurs will have less business-related taxation throughout the year, but more so - it's easier for owners to simply pass through any losses and profits under self-employment taxes. Overall, these forms of business create the opportunity for entrepreneurs to create more stability for long-term financial security.