Sole proprietors have several options when keeping their accounting records up to date. They use books and ledgers, computer software or third parties to track their purchases, sales and revenues. Not having accurate accounts of transactions and cash flows can lead to tax and legal consequences for sole proprietors.
Sole proprietors handling their own accounting can spend a lot of time keeping accurate records of their transactions. They have to separate personal and business sales and purchases into different files to minimize confusion and accounting errors. Opening and monitoring separate bank accounts and credit cards solely for business purposes are time consuming as well.
Paying and Withholding Taxes
Sole proprietors must also account for paying local, state and federal income taxes as well as self-employment taxes, covering Medicare and Social Security. As of 2011, the self-employment tax rate was 13.3 percent on sole proprietors’ first $106,800 in incomes according to the IRS. This is down from 15 percent in 2010.
As owners, sole proprietors also have to account for withholding taxes from employees’ pay and paying them to the Internal Revenue Service. Employers must withhold payroll taxes such as federal, state, local as well as Medicare and Social Security from employees’ paychecks. Sole proprietors who do have employees pay unemployment taxes as well. If accounting becomes burdensome or complicated, sole proprietors can outsource this part of the business to professional accountants.
Sole proprietors don’t have to file special tax returns; business profits and losses are reported on their 1040 individual tax forms under Schedule C. When reporting profits and losses, sole proprietors use the pass-through taxation process, which is used by partnerships, limited liability companies, LLCs and S corporations. Pass-through taxation flows business profits to sole proprietors, where it is taxed at regular income-tax rates.
Without accurate accounting, sole proprietors lose out on tax breaks and can cause serious tax problems. For example, business owners can deduct group health-care coverage as well as meals and gas usage as business expenses if they have receipts. If sole proprietors omit, or submit, incorrect information on their tax forms due to inaccurate accounting records, audits, fines and other penalties could ensue from the IRS.
No Limited Liability Protection
Sole proprietors do not have the limited liability protection afforded to owners of other companies such as corporations and limited liability companies, or LLCs. This means sole proprietors are held personally liable for their companies’ actions and debts. If accounting errors result in damages or losses to customers or vendors, unpaid taxes or bankruptcies, sole proprietors could lose their homes, cars and other personal assets to pay off lawsuits and creditors.
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