Forms of taxation of sole proprietorships
Do you plan to run a business as a sole proprietorship? You have many decisions to make which may turn out to be critical for the future of your business. One of these decisions concerns the selection of the taxation method. As a sole proprietor, you can select one of the following three taxation methods. What are these? What are the differences between them? You can learn that from this post.
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From the beginning of 2022, when starting a sole proprietorship, you can choose one of three forms of taxation - standard taxation rules, flat-rate tax, lump sum tax on registered income. There is also the simplest form of settling accounts with the tax authorities in the form of a tax card. However, it can no longer be selected. It can still be used only by businesses which have paid taxes in this way in previous years.
Standard taxation rules
Standard taxation (tax scale) is a default form applied by the tax authorities automatically if you do not select a different one during the process of starting a sole proprietorship. It is the same as the taxation applied to people who do not engage in business activity.
Tax thresholds and health insurance contribution.
Tax progression is used in this solution. Annual incomes up to PLN 120,000 are subject to taxation at 17 percent, and income in excess of this amount at 32 percent. In addition, a health insurance contribution of 9% of income must be paid every month. When no income is earned in any given month, or when it does not exceed the minimum remuneration, the health insurance contribution has to be calculated on the basis of the minimum remuneration effective as of 1 January of the given year. In 2022, this is PLN 3,010, therefore the minimum monthly health insurance contribution for sole proprietors is PLN 270.90.
Costs and allowances – how to pay lower tax
However, with standard taxation, you can use various mechanisms available to reduce the tax base. First of all, you are subject to a personal allowance, so you can deduct PLN 30,000 from your annual income for 2022. You can also disclose tax deductible costs in accordance with applicable regulations.
The amount of tax due is also reduced by allowances that you can take advantage of with standard taxation. It includes, among others, pro-family allowance and the possibility of making joint settlements with one's spouse, which is particularly advantageous in a situation where there is a large disproportion in the spouses’ earnings.
Middle class allowance – how much is it and how to calculate it
There is also a special allowance for those settling according to standard taxation, whose annual revenues are in the range of PLN 68,412 to PLN 133,692. This is the so-called middle class allowance. Its purpose is to compensate employees and businesses for the increase in tax burdens when compared to the status before 2022.
For those earning annually from PLN 68,412 to PLN 102,588, it is calculated according to the following formula:
allowance = (annual revenue x 6.68 percent – 4,566) ÷ PLN 0.17
For those earning above PLN 102,588 but no more than PLN 133,692 it is calculated as follows:
allowance = [annual revenue x (-7.35%) + 9,829] ÷ PLN 0.17
Therefore, depending on income, it ranges from just below PLN 16 to nearly PLN 13,500 per year.
The flat-rate tax for sole proprietors is a much simpler solution than standard taxation. Regardless of the income generated, you will pay a single tax rate of 19 percent.
The health insurance contribution that you also have to pay with this form of taxation is lower than that covered by those who pay tax on at the standard rate. With flat-rate tax, it constitutes 4.9% of the income.
Costs yes; allowances no
With a flat-rate tax, as in the case of the tax scale, you can reduce the amount due to the tax authorities by virtue of tax deductible costs. These, of course, must be directly related to the business and be properly documented.
Unfortunately, with this form of taxation, you will not be able to make use of other tax reduction mechanisms. The personal allowance which amounts to PLN 30,000, the possibility of joint settlements with the spouse and various types of tax allowances are reserved only for those settling according to standard taxation rules.
Flat-rate tax - when is it worth it?
Total charges in the case of flat-rate tax – 19 percent tax and 4.9 percent health contributions – are lower than in the case of standard taxation: 17 (32) percent and 9 percent respectively. At first glance, it might seem that the flat-rate of tax is more cost-effective for sole proprietors.
However, the absence of tax allowances and the personal allowance means that the flat-rate tax becomes beneficial only above a certain level of income. If you cannot take advantage of any of the allowances or joint taxation with a spouse, the flat-rate tax is more advantageous with an annual income of above PLN 120,000. However, in the case of joint taxation with a spouse, this limit increases to above 150 thousand. – this is due to the application of a doubled personal allowance.
Each subsequent allowance that you can use with standard taxation causes the cost-effectiveness of the flat-rate tax threshold to be moved even higher.
Lump-sum tax on registered revenues
The third form of taxation that you can choose when running a sole proprietorship involves a lump sum tax on registered revenues. This is the easiest way, but at the same time it is subject to certain conditions.
The lump sum tax is intended for businesses operating in one of the sectors listed in Article 12 of the Act on lump sum income tax on certain revenues generated by natural persons. Moreover, in subsequent years of operating a sole proprietorship, you can continue using this taxation method provided that you do not exceed the limit of EUR 2 million (calculated according to the average NBP exchange rate on the first business day of October of the previous year).
No allowances or costs
As the name implies, in the case of lump sum taxation, the tax due is calculated on the total revenues rather than income. With this form of taxation you will not be able to deduct any costs incurred. You will also not benefit from allowances and joint taxation with a spouse. The tax base, as in the two previous forms, is only reduced by ZUS (social insurance institution) contributions.
Tax and health insurance contribution rates under the lump sum tax system
The health insurance contribution under the lump sum tax system is 9%. However, unlike the other two forms of taxation, it is not based on the company’s actual revenues. It is based on “the average monthly remuneration in the business sector in the fourth quarter of the previous year, including payments from profit, as published by the President of the Central Statistical Office in the Official Journal of the Republic of Poland”.
If a company’s revenue from the beginning of the year does not exceed PLN 60,000, the monthly health insurance contribution is calculated on 60% of the above-mentioned average remuneration. With revenues of between PLN 60,000 and PLN 300,000, the level of health insurance contributions is calculated on the basis of 100%, and with higher revenues it is based on 180% of the average remuneration.
It should be noted that in connection with increasing revenues, you may exceed subsequent thresholds during the year. In that case, your monthly health insurance contribution will increase, but so will the final sum of your annual contribution. You will have one month from the deadline for submitting your tax return to pay the difference.
With respect to tax rates, there are 10 tax rates under the lump sum tax system and these range from 2 to 17 percent. The tax rate applicable to your business depends on the sector you are operating in as well as on the revenues generated. Details can be found in Art. 12 of the above-mentioned Act.
Who does lump sum tax benefit
Although the tax rates in the case of lump sum tax are generally lower than those covered by standard taxation and flat-rate tax, the lack of deductibility costs and benefiting from allowances does not make it a solution that is to everyone's advantage.
According to experts, it is worth taking advantage of the lump sum tax system if your business is highly profitable, meaning that costs do not exceed 20–30% of revenues. It depends, of course, on the tax rate, and therefore on the sector you operate in. In a situation where costs exceed the 30 percent level, you should rather choose one of the other two forms of taxation.