11 minute read
Of the 150 million workers in the United States, 16 million — or roughly 10% — are self-employed. Although self-employed workers do share a few key characteristics, America’s sole proprietors are a diverse group that varies in age, ethnicity, gender and education level.
Many businesses start off as sole proprietors, as they are relatively easy to set up, even for the inexperienced, and they offer individuals the freedom to set their own schedule and work as they want. As an added benefit, sole proprietors are eligible for a host of deductions and credits that individual taxpayers cannot claim.
Here are nine of the most helpful deductions and tax credits for sole proprietors.
The qualified business income deduction, commonly known as the QBI deduction or the Section 199A deduction, is a temporary tax law that was established with the passage of the Tax Cuts and Jobs Act (TCJA). In tax years 2018 through 2025, certain sole proprietors can take deductions equal to 20% of their business income, with adjustments.
Payroll taxes, which include both social security and Medicare taxes, are shared equally between employer and employee. Sole proprietors don’t owe payroll taxes, but they do owe a self-employment tax. The current self-employment tax rate is 15.3% – 12.4% for social security and 1.9% for medicare. Fortunately, sole proprietors can deduct half of their self-employment tax. This deduction helps make the additional costs of sole proprietorship more accessible to the average taxpayer.
Establishing new businesses can be costly, but sole proprietors may be able to deduct or expense some of their startup and organizational costs. Common business startup and organizational costs are:
Typically, these costs are considered capital expenditures and must be amortized (i.e., deducted) equally over 180 months, but the IRS allows new businesses to deduct up to $5K in startup costs and up to $5K in organizational costs in the first year of business.
| Startup Costs | Organizational Costs |
| Attorney, accountant or consultant fees to help establish business practices and contracts | Location rental costs for organizational meeting with the board of directors |
| Costs to identify potential business locations, distributors, suppliers or labor supply | Cost of temporary directors |
| Advertisements for the opening of the business, including website development | Attorney and legal costs to establish the business with the state or secure business licenses |
| Salaries and wages to train staff | State incorporation fees |
Travel is an ordinary and necessary expense of running a business, which means that travel expenses are fully deductible for sole proprietors. Travel expenses that can qualify for the deduction include:
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Personal vehicle costs are deductible, but only when the vehicle is being used for business purposes. Because most sole proprietors use their vehicles for both personal and business use, the IRS helps taxpayers calculate the appropriate deduction. There are two methods to choose from:
Standard mileage rate. For each business mile driven, sole proprietors can deduct 56 cents in 2022. This mileage deduction is simple to calculate and requires little expense tracking, which can be appealing to busy sole proprietors. You will need to keep an accurate log of business miles traveled.
Actual expenses. Sole proprietors can deduct the actual expenses they incur when traveling for business. First, they must calculate the total costs of operating their vehicle, which might include fuel costs, depreciation, wear and tear, repairs, oil changes, car insurance and registration fees. They must then multiply those costs by the percentage of time they used their vehicle for business purposes.
Many sole proprietors opt to take the standard mileage rate because of its simplicity, but if actual expenses are readily available, they can calculate both and take the higher of the two deductions. It should be noted that if you choose to take any depreciation for a vehicle other than straight line, you can not switch back to standard mileage until the vehicle is fully depreciated.
Like the vehicle use deduction, the home office deduction can be calculated in one of two ways:
Standard method. To calculate the deduction, the business owner must determine the percentage of their home used in their business based on square footage. They can apply that percentage to household expenses that are shared by the business, including mortgage, utilities, homeowner’s insurance premiums and even depreciation.
Simplified method. The IRS allows a deduction of $5 per square foot of the home used for business (maximum of 300 square feet).
Although the Tax Cuts and Jobs Act made meals more difficult to deduct, most business meals are at least 50% deductible to sole proprietors. Here is a quick summary of what meals are deductible:
| Tax Years 2021–2022 | Tax Years 2023+ | |
| Meals while traveling for business | 100% deductible | 50% deductible |
| Meals at off-site meetings with clients or prospects | 100% deductible if provided by a restaurant (take-out or delivery is allowable) | 50% deductible |
| Office holiday parties with employees | 100% deductible | 100% deductible |
| Meals where there is an entertainment aspect to the event | Meals costs are 100% deductible if separately stated and provided by a restaurant, otherwise not deductible | Meals costs are 50% deductible if separately stated, otherwise not deductible |
| Everyday lunch at the office or at home | Not deductible | Not deductible |
Sole proprietors can establish their own retirement plans, and contributions their business makes into those retirement plans are deductible. Three retirement plans sole proprietors can consider are the solo 401(k), the SIMPLE IRA and the SEP-IRA.
| Solo 401(k) | SIMPLE IRA | SEP-IRA | |
| What is it? | Also called an individual 401(k) or a one-participant 401(k) | Savings Incentive Match Plan for Employees Individual Retirement Account | Simplified Employee Pension Individual Retirement Account |
| Who is eligible? | Sole proprietors with no employees other than their spouse | Businesses with up to 100 employees | Any business, but is best for businesses with no or few employees |
| What is the deduction? | The business makes contributions to the owner’s account, and the owner defers compensation to the account as well.Those contributions are deductible. | The business makes contributions to employees’ accounts. Those contributions are deductible. | The business makes contributions to employees’ accounts. Those contributions are deductible. |
| How do contributions work? | The business can make profit-sharing contributions up to 25% of the sole proprietor’s net business income. Separately, the business owner can make elective deferrals based on their net business income, not to exceed IRS limits. Combined, contributions cannot exceed $61K for 2022.* | The business makes either (1) matching contributions on up to 3% of the owner’s net business income, or (2) guaranteed contributions of 2% of net business income. Separately, the business owner can make elective deferrals of their net business income, up to $14K for 2022. | The business must contribute an equal percentage of salary for each employee, up to 25% of compensation or $61K for, whichever is less. Compensation for sole proprietors is business net income. |
Sole proprietors that provide their employees with health insurance can receive a credit of up to 50% of health care premiums paid. This credit is available for two years. Sole proprietors will be eligible for the credit if they:
This credit is highest for companies with 10 or fewer employees who are paid an average of K or less, which makes it a great option for a sole proprietor with few employees.
These are just a few of the most helpful deductions and credits for sole proprietors. A few other common deductions are for internet, interest on business loans, subscriptions and fees, professional services, education and training costs and business insurance. An additional list of small business tax credits can be found here.
These deductions and credits can significantly change a sole proprietor’s tax liability, so it’s worth taking the time to explore each option. With Corvee’s Tax Planning software, you can see how much of a benefit each incentive will give you so you can determine for yourself which ones are worth pursuing.
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