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use an example, and I will use taxpayer Jane and taxpayer John to demonstrate it.

Taxpayer Jane is an employee. She's single, no dependents, and made $50,000.00 during the tax year. Taxpayer John is a sole proprietor. He's single, no dependents, and had gross receipts of $50,000.00. In essence, all things are equal between the two taxpayers. Both will be filing short form, and I will reconcile each ones taxes based on 2007 tax charts with simplified rules, percentages, etc.

Tax payer Jane: Through out the year, Jane would have paid approximately $3875.00 in Social Security and Medicare Tax on her $50,000.00 in income, and Jane would have a Federal tax liability of $6,730.00. This is what should have been withheld from her paychecks throughout the year. She would pay a total of $10,605.00 between Social Security, Medicare, and Federal Taxes.

Tax payer John: As a sole proprietor with $50,000.00 in gross receipts and no business write-offs, John would be paying about $5645.00 in federal tax. His Self Employment tax would be about $7750.00 for a total of $13,305.00, about $3,000.00 more than Jane.

In reality, though, John will have business deductions that Jane could never deduct from her income. Assuming 30% of John's income went toward business expenses, not an unreasonable amount, I'll re-work is tax liability. At 30% in expenses, John's net income is now $35,000.00 which leaves him with self employment tax of $5,355.00 and a federal tax of $3,070.00 for a total of $8,425.00 in total taxes, over $2,000.00 less than Jane. So, because sole proprietors can write off business expenses that employees can not write off, the overall tax for sole proprietors could actually be less.

The general rule for deductible business expenses for sole proprietors is anything that pertains to that particular business can be deducted. Some general expenses would be postage, office materials, office expenses (utilities, rent, etc.). Another expense is car expense. There are two ways to deduct car expenses, the first being actual expenses and the other using a standard mileage deduction for all business miles. Equipment can also be a deduction. The guidelines for deducting certain equipment requires the sole proprietor to actually depreciate the equipment over time. Home office expenses could be a deduction, but beware the guidelines for this expense are very strict and must be adhered to in order to take the deduction. If the proprietor's business does qualify for home office expense an equal portion of utilities may also be deducted. For example, if the home office makes up 10% of the home in terms of space, 10% of utilities for the year may also be deductible.

In addition to general business expenses, each business will have expenses pertaining only to their type of work. An example of this could be someone who earns self employed income by donating their blood, might be able to write of a portion of their grocery bill where this would be a completely ridiculous expense for a mechanic.

Taxes vary per person based on several factors, and only a professional tax preparer can decide what could be considered for deductions and what is not. But self employment tax for sole proprietors is not the "bad" tax it is made out to be. Personally, I don't enjoy having to pay any taxes, but if I do have to pay, why not use the tax laws to my advantage, and pay the least amount possible.

Sources: www.irs.gov
My own past experience as a tax preparer
Disclaimer: rules and figures used for examples are simplified for demonstration purposes only.

Learn more about this author, Dori Beldi.
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