No, you don’t need to register your business to claim your expenses. As long as you have met the required laws and followed the below-discussed procedure, you can claim or deduct your operational business expenses.
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Definition of an Unregistered Business
As much as you might not want to be one, starting a firm without registering it makes you a sole proprietor.
So, a sole proprietorship refers to a business that isn’t registered. With this legal structure, you’re expected to use your Social Security Number (SSN) instead of the Employer Identification Number Manager Identification Number (EIN) and your legal names as your company’s name.
Although you can be permitted to operate as a sole proprietorship without registration, you’re required to comply with your local government when it comes to the collection and filing of taxes(both federal and state).
You can run your business without registering it as long as the business meets all licensing and tax requirements and is legal.
Although businesses should be registered before commencing any operations legally, the procedure differs from consolidating a firm.
You may be held accountable for any damages relating to your company if it isn’t registered as a limited liability company offering protection against personal liability.
Sole Proprietor Taxes
Sole proprietors are responsible for paying:
1. Federal Income Tax
For a sole proprietor, taxes for both the business and self are done together. This is because; your sole proprietorship income is also your income. For reporting income (profit or loss) and expenses, one should use Schedule C and the standard Form 1040, which is used to report personal income.
Your tax bracket and amount of income owed is determined by your combined income from both schedule C and 1040 forms
2. Self-Employment Tax
If employed, your social security and Medicare tax are usually deducted off your pay. But in this case, a self-employed sole proprietor is fully responsible for paying these taxes themselves.
Below is a guide on how this tax is broken down:
- 12.4% goes towards Social Security tax, on up to the first $132,900 of your income.
- 2.9% goes towards Medicare tax.
In general, a rate of 15.3% is taxed for self-employment. If your total income is above $200,000 as a single filer or $250,000 for individuals those that are married and file jointly, then you’ll pay the extra Medicare Tax of 9%.
Your payroll tax amounts are reported on Schedule SE each financial year when you file your federal tax return.
3. Federal and State Estimated Taxes
This is not a special tax, but tax paid in advance for projecting the amount to be owed for your income and self-employment tax at the end of the tax year.
Federal and state estimated taxes are due quarterly in January, April, June, and September. They should be filled by the 15th of each respective month, but if it falls on a holiday or weekend, an exception is allowed, and filling can be done the next business day.
This tax is filed using form 1040, but your previous income should have been filed in April. Point to note is that one should pay enough estimated taxes each quarter to avoid underpayment penalties.
4. Sales Tax
This mainly depends on your state. This tax is made for selling products or services. It is recommended you visit your state department of revenue for details on how to pay or file this particular tax.
Tax Deductions for Sole Proprietorships
Being a sole trader, you are in charge of your business. Therefore, it means you have additional responsibility on taxes and reporting requirements, but the excellent news is you are eligible to claim business expenses.
Some of the most common deductions available to sole proprietors include:
1. Home Office Deduction
The majority of unregistered businesses often use home-based offices. The internal revenue service states that the cost incurred for using the home office is deductible and recoverable in business expenses as long as the office is the first place of transacting business.
Examples of home expenses include; insurance, cost maintenance of office items like furniture, phone repair, computer repair, and utilities, among others.
- Contributions to self-employed retirement funds, such as a SEP IRA, are also deductible.
- Traditional individual retirement account contributions.
- Contributions to a Health Savings Account with a high deductible health plan.
- Marketing and advertising expenses are also deductible if only incurred for business promotion.
- Interest in business loans: Interest that you pay for the loan is recoverable and can be claimed. Always deduct interests that you have paid for your business loans only.
- Bank fees. For any transaction cost that is incurred on your business account should be deducted before paying your taxes.
- Education expenses related to the business. For any knowledge, you seek to acquire new business or for the growth of the company or success of your business is deductible.
- Legal and professional fees. One has a right to deduct any professional fee charged but should only be done for business purposes or services strictly rendered to the business.
- Telephone and internet service that only relates to the business operation is as well deducted.
- Business meals: this can only be claimed if you have proof that the cost incurred on meals was exclusively for business purposes and was paid fully, but if the client paid for their meal, a 50% expense could be deducted.
2. Business Use of Your Car
The cost incurred for using your car for your business can be removed. For example, you are driving to meet your clients at their location away from your office. The cost of commuting is always tax-deductible only if the cost incurred is business-related.
3. Ways of Claiming Mileage
Using the Standard Mileage rate by adding the miles you drove and multiplying by IRS’s standard deduction rate and then deducting the equivalent amount. For example, as of 2019, if the rate was 58% per mileage, and if I traveled for 1000 miles, I would deduct $580 (0.58*1000miles).
Adding up all your car expenses, these include repairs, insurance, gas, car depreciation value, etc. Therefore, you add all liabilities on your car that year and deduct the value.
4. Taxes and Licenses
Some of the taxes that you can deduct include part of your self-employment tax, franchise, and occupational taxes, among others that IRS updated on their site.
5. Health Insurance
As a sole proprietor, one is entitled to deduct the cost of their medical insurance for themselves, spouse, and dependents. Alternatively, this deduction being above-the-line this is to say is taken off your gross income before your net profit.
But this is limited to the amount of taxable income. If you make a loss on your business, you can’t take the medical insurance deductions. Also, if your spouse is eligible for a group cover with an employer, you are not allowed to deduct the same.
The above deductions should be made as per the IRS guidelines. Feel free to familiarize yourself with the same since they can be amended from time to time.