Sole Proprietor Schedule C – Sword of the Crypto Earner
Crypto Earners and Tax structures, Pt 1.
Disclaimer
None of the following is tax advice, it is just prompting the reader towards ideas, topics and questions for their own research or to bring up with a tax professional. Your own family situation, goals and residence have a tremendous impact on your specific tax plans so DYOR, and at least consult a tax pro if you can afford it
Intro
If you are starting out as a self employed person in the crypto universe one of the biggest administrative burdens you have is tax and bookkeeping. Digging around online you might find advice stating that you should start an LLC, or a corporation or an S corporation. While these are tax efficient strategies, they may not be the best beginning strategy or even advanced strategy depending on your time and income. Like anything else it also involves personal preference.
This article is intended to help you decide if a Sole Proprietor structure is right for you. In general the Sole Proprietor structure is like a sword in the hands of a knight. Straight forward, fast and effective. There are a lot of other more colorful choices of weapons to use but they take even more time to learn and master. Let’s get into the details of how to evaluate this structure for yourself in the next section.
Don’t I need an LLC?
Let me start off by covering one first piece of common advice. That advice is that you have to have an LLC for anything you do. This is a generic piece of advice that isn’t applicable to everyone. First off, an LLC really just provides a home for your business assets, or a barrier between yourself and your business if you have employees. If you are the one doing the work, you most likely can’t hide behind an LLC if there is a problem. Second, an LLC is not required to start or house any kind of business. You are able to run a business under your own name without any extra work, and minimal work if you just want to have a doing business as name. Third, an LLC if you are not using if for any kind of anonymity or asset separation is just extra work and fees. You have to have some kind of LLC operating agreement, pay filing fees to the state it is registered in each year, have a registered agent address and keep up with annual filings. You’ll even end up paying extra income tax to have an LLC in some states like Tennessee. Finally, an LLC is advantageous if you want to change tax structures over time, such as to a corporate tax treatment as you can preserve the LLC at the state level but just do tax elections at he federal level.
The summary is, if you are just a person providing personal services as a sole proprietor and LLC could be overkill and not even be a substitute for liability insurance. That being said, try and get any kind of insurance and tell the underwriters that it’s for something with crypto and you’ll likely get a big lol.
Tax disadvantaged
The tax treatments for a sole proprietor tax structure are nothing special. There are some handy deductions you can use but the biggest drawback is having to pay self employment taxes of about 15% in addition to your income tax. Prior to 2020 I remember when even this could be bulldozed over by someone earning a good net profit as the self employment tax cut out at close to $100,000 but as of 2023 you are paying it all the way past $160,000 and that will continue to increase. That is a huge tax hike on self employed people that is not covered widely enough.
It is not the end of the world though. Paying some self employment tax up to around $35,000 isn’t a bad idea as it gets you into some disability and basic retirement benefits if you need them in a poverty situation. Furthermore, other business structures are still going to have you paying the equivalent of self employment tax just in a circuitous route and it’s not a total waste of time paying it on under $60,000 of net profits.
One other part of self employment tax that is overlooked is that you get hit with it on the first dollar of profit. With income tax, you have to cross your standard deduction to get to your first dollar of tax. That means if you only had $10,000 in total income for the year, but it was from self employment, you would owe zero federal income tax, but $1500 in self employment tax. One the income tax side, having a standard deduction, combined with nicely graduated income tax brackets at the lower levels means that you should be more worried about self employment tax than federal income tax up to about $50,000
On the deductions side, something nice that still exists for now is that you also get a small business tax reduction from a sole proprietorship in the amount of 20% of your net income, which reduces your income tax (not self employment tax) even further. You can also get an easy deduction for health insurance from your net profits from a sole proprietorship that is significantly less hassle than doing it through other tax structures. The small business tax deduction for a sole proprietorship also has fewer gotcha limiting elements to it that S corporations have.
Administratively advantaged
After reading about the tax disadvantages of of a Sole Proprietorship you may be wondering why anyone would use it at all? That is where the unwritten advantage of a Sole Proprietorship come in and that is speed. Sole Proprietor structures are fast moving and administratively light weight, especially when done directly as the business owners name. You just should have a separate bank checking account, but not necessarily a business account. For crypto offramps, you can get away with just setting up a separate CEX offramp in your own name, which is very fast compared to the KYC etc process for using a business. For example, use Coinbase for your personal stuff and Binance for your business and you are off to the races.
You still need to keep accurate accounting records, but your tax reporting is much simpler than other business structures. You report income and expenses but not any balance sheet information on the taxes and you just attach and extra 2 pages to your personal return versus doing an entirely separate tax return for other structures. A sole proprietor structure is also easy to exit out of if you grow large enough to change business structures, or need to hire employees. The assets of the business are just held by you personally and can be contributed to another structure easily if you need to.
On an annual maintenance standpoint, for the sole proprietor you maybe will have to renew a local business license but that is all versus a number of administrative annual tasks for LLCs, S corps and C corps.
Doxxing disadvantaged
A sole proprietorship structure, especially when running just under your name is doxxing disadvantaged. It’s your name, and likely your address behind it and going on some public records and tax records. You can get a separate tax ID number, but you are likely still going to get tax forms issued to your personal SSN. Tax debts, and other debts are attached to you personally and so your personal ID/signature is going to get a lot of exposure. It’s not the end of the world, but something to be careful with. There are privacy options to try and minimize this but again, they ramp up the administrative burdens as you implement them.
Don’t forget about the locals
One last business item for all structures that tends to get overlooked is local compliance obligations. Most people know about the burdens of federal income tax, some people know about the impacts of state taxes but unless you have a physical storefront most people forget about local tax implications.
Local tax administration includes knowing about your city or county business license requirements, possible sales taxes and the worst of all being personal property or inventory taxes. They vary a lot by jurisdiction, but the point of this paragraph is just to put on your mind to look them up for where you are situated.
Best income levels to use Sole Proprietor
Sole proprietor strategies work best at zero to about $80,000 in net profits. Once you get up towards the higher levels in net profits it may be worth looking at other structures for tax savings. This is all very situational as well as your other earnings, family structure, stage of life, goals as well as your state of residence can impact these things.
If in doubt
Finally, if you are in doubt as to what you are doing, at least keep good records of receipts, invoices, credit card statements, bank statements and wallet addresses. You can always unwind or rebuild from that. Good luck out there, and I hope you feel a bit better equipped as a crypto earner or just any self employed person.