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Tax Implications for Sole Proprietors and Self-Employed Consultants

Picking up a second job to supplement household income in a tough economy is becoming more common. Many Americans are choosing to become consultants that visit homes to sell make-up, jewelry, candles, kitchen utensils and food products. Some may not realize the tax implications of becoming a sole proprietor and what they need to do to file taxes.

Conducting business as a sole proprietor is one of the simplest forms of operation. It’s easy to start a business operated as a sole proprietorship and equally easy to discontinue. Your first step when starting a business is to open a separate business checking account. It will be easier to track your deductible expenses if they are not commingled with your personal expenses. If you incurred expenses prior to opening your business, keep them separate from your other expenses. Special tax treatment applies to startup expenses.

It is important to keep track of your mileage, as you might be eligible to deduct it. If you are self-employed and maintain an eligible office in your home (more on this later) you can deduct the mileage to and from your client’s or customer’s place of business, as well as between jobs. There are two ways to calculate your auto deductions – the standard mileage rate or actual expenses. The standard mileage rate is the easier method as you simply take your total mileage and multiply it by the current rate ($.555 for 2012). The actual expense method is exactly that, recording the actual expenses such as the cost of gas, oil, insurance, repairs, maintenance, tires, washing, licenses and depreciation. This method requires you to keep very detailed records and if you use your car for personal and business purposes, you’ll have to divide the expenses between the personal and business portion.

The IRS allows self-employed taxpayers to claim a deduction for home-based business expenses if they meet certain requirements. They must use the home office regularly and exclusively:
– As the principal place of business for a trade or business.
– As a place to meet with customers in the course of the trade or business, or in connection with the taxpayer’s trade or business, if the location is in a separate structure not attached to the dwelling unit.

The IRS may allow a deduction for inventory storage if the product is regularly sold to others and there is no other fixed location available for the business. Home office calculations are divided into direct and indirect expenses. Direct expenses are those that pertain exclusively to the home office, such as painting the walls or installing new carpet. Indirect expenses are those that pertain to the entire residence, such as rent, mortgage interest, taxes, insurance, repairs, utilities and depreciation. Indirect expenses need to be allocated between the business and non-business portions of the home. The amount of expenses you can deduct is subject to specific limitations and ordering provisions. Please contact a tax professional for guidance.

If you have any questions regarding a sole proprietorship or being a self-employed consultant please call Palma Financial Services in Dublin, CA. We are a full service CPA, Accounting, Financial Services firm.

Information for this article originally appeared at National Association of Tax Professionals. Learn more at  www.natptax.com.

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