Sole Proprietorships Defined

 

Fringe Benefits
If you operate your business as a sole proprietorship, tax-sheltered retirement programs are available. A Keogh plan, for example, allows a sole proprietor to salt away a substantial amount of income free of current taxes. You can't really do any better by setting up a corporation.

A corporation does have an advantage when it comes to medical expenses for the owner and his or her spouse and dependents. As a sole proprietor, you can deduct only 40% of your family's health insurance premiums on Form 1040. You can deduct the remaining 60% as an itemized deduction on Schedule A, but only to the extent that the 60% of the premiums, plus other uncovered medical expenses, exceed 7.5% of your adjusted gross income for the year. If you form a corporation, however, and hire yourself as an employee, the corporation can pay for 100% of your family's health insurance premiums and uncovered medical expenses and then take these amounts as a business deduction.

Hiring Your Spouse Can Have Tax Benefits
If you choose to do business as a sole proprietor, there's a way you can deduct more of your family's medical expenses. First, hire your spouse at a reasonable wage. Then, set up a written health benefit plan covering your employees and their families. A sample form is shown below. Your business can then deduct 100% of the medical expenses it pays.

But balance whether such a plan can save you enough money to justify the effort. There may be some expense for setting up the plan and handling the associated paperwork. And remember that your business will be obligated for payroll taxes on your spouse's earnings. But this isn't all bad since your spouse will become eligible for Social Security benefits in his or her own right, which can be of some value -- especially if he or she hasn't already worked enough quarters to qualify.

If you're audited, the IRS will look closely to make sure that your spouse is really an employee and performing needed services for the business.

Recommended Reading
To learn about how a person qualifies for Social Security benefits, see Social Security, Medicare, and Pensions, by Joseph L. Matthews (Nolo).

Sample Reimbursement Plan
Sam Jones, a sole proprietor doing business as Jones Consulting Services (the Company), establishes this Health and Accident Plan for the benefit of the Company's employees.
  1. Coverage. Beginning January 1, 20XX, the Company will reimburse each employee for expenses incurred by the employee for the medical care of the employee and the employee's spouse and dependents, and for premiums for medical, dental, and disability insurance. The medical care covered by this plan is defined in Section 213(d) of the Internal Revenue Code. Dependents are as described in Section 152.
  2. Direct payment. The Company may, in its discretion, pay any or all of the expenses directly instead of reimbursing the employee.
  3. Expense documents. Before reimbursing an employee or paying an expense directly, the Company may require the employee to submit bills and insurance premium notices.
  4. Other insurance. The Company will reimburse an employee or pay bills directly only if the reimbursement is not provided for under any other health and accident or wage continuation plan.
  5. Ending or changing the plan. Although the Company intends to maintain this plan indefinitely, the Company may end or change the plan at any time. This will not, however, affect an employee's right to claim reimbursement for expenses that arose before the plan was ended or changed.

Dated: December __, 20XX

Sam Jones, doing business as Jones Consulting Services

Routine Business Expenses
Day-to-day business expenses can be deducted in the same way for a sole proprietorship and a corporation. Whether it's car expenses, meals, travel, or entertainment, the same rules apply to both types of business entity.

You'll need to keep accurate books for your business that are clearly separate from your records of personal expenditures. The IRS has strict rules for tax-deductible business expenses, and you need to be able to document those expenses if challenged. One good approach is to keep separate checkbooks for your business and personal expenses -- and pay for all of your business expenses out of the business checking account. But whatever your system, please pay attention to this basic advice: It's simple to keep track of business income and expenses if you keep them separate from the start -- and murder if you don't.

Copyright © 2000 Nolo.com Inc.

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