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Popular Business Entity Brings tax Problems ( And opportunities )
Sole proprietorships are often the default business option for a business owner . these businesses only have one owner , after all . they require no business name . they don ’ t require their owners to open a separate bank account . they don ’ t create paperwork .
“[ it ’ s ] the easiest and most affordable way to organize a business because there is no separate legal entity created and no other business owners to consider ,” says the blog of accounting firm drucker & scaccetti in Philadelphia . easy ? yes and no . for instance , sole proprietorship owners have to deal with special tax burdens . they have to estimate and pay quarterly taxes , for instance . they also have to pay a self-employment tax , something that would otherwise be covered by an employer on behalf of an employee , says jon ekoniak , managing partner at Bordeaux wealth advisors in menlo Park , calif . also , sole proprietors can ’ t turn to other owners to shoulder the burdens of taxes , debt and estate planning . and when sole proprietors have no designated successor , their businesses die with them . yet these entities also offer their owners tax breaks : they are pass-through entities , so their owners can deduct up to 20 % of net business income from their taxes , with some restrictions on income and other factors . though income is reported directly with the owner ’ s personal income tax return in the year it ’ s earned , with no additional paperwork , sole proprietors ’ business income is subject to an additional 15.3 % self-employment tax for contributions toward medicare and social security , drucker & scaccetti notes .
“ most people understand their personal tax situation from the viewpoint of the employee ,” ekoniak said . “ they often lack a deep understanding of the obligations and benefits of the employer . the sole proprietor is the Hr , accounting and benefits department all wrapped into one , so it ’ s difficult to keep up on all of those responsibilities and run a business .”
He noted other areas where sole proprietors can take advantage of tax breaks . “ we rarely see [ them ] taking full advantage of their retirement planning opportunities ,” he says , adding that the simplified employee Pension ( seP ) ira has been “ the go-to retirement plan for sole proprietors for many years due to the low startup and maintenance costs and the [ owner ’ s ] ability to contribute 25 % of income ” up to a maximum of $ 61,000 for 2022 . the solo 401 ( k ) is also overlooked : it , too , has low startup and maintenance costs but allows owners to make contributions “ as both an employee and an employer ,” ekoniak says . the total maximum contribution is the same as the seP ira , but “ the employee can contribute up to 100 % of the IrS says that the number of sole proprietorship returns showing LLC status has jumped more than 16 times in the past two decades .
their income with a maximum of $ 20,500 to their solo 401 ( k ) as an employee ... and then approximately 25 % of their income as the employer ,” he says .
“ when you get into higher levels of income for older employees , a defined benefit plan may allow you to contribute even greater amounts , up to $ 245,000 for 2022 ,” ekoniak says . “ there are more reporting requirements and maintenance costs for a defined benefit plan , so it makes the most sense for those with higher income levels . one can also combine a defined benefit plan and a solo 401 ( k ).” these business operators do need to track and document deductible tax expenses precisely . “ when one is working from home , work and personal lives tend to blend ,” ekoniak says . “ it ’ s important to be very diligent in tracking exactly what ’ s used for the business .” sole proprietors are also personally liable for business debts — even their personal
12 | financial advisor magazine | july / august 2022 www . fa-mag . com