When you’re a self-employed, freelancer, or solo entrepreneur, correctly filing your income tax return might save money by preventing unnecessary penalties and missed deductions.
Whether you file your tax return with online software or hire a tax professional, understanding Schedule C, Profit or Loss From Business may play a crucial part in providing the best information to generate an accurate return. Get ready to prevent stress and save time by mastering the basics of Schedule C, Profit or Loss From Business.
Short Summary
- Schedule C is a form used on an individual’s income tax return to report income or loss from freelance work, work as a solo entrepreneur, contract work, or any solo self-employed person, often referred to as a sole proprietorship on tax forms.
- Schedule C is the form where details about your self-employment business are reported, such as product or service type and accounting method.
- Income and expenses are reported and used to calculate your business’s net income or loss.
- In addition to business details, Schedule C has five parts: Income, Expenses, Cost of Goods Sold, Information on your Vehicle, and Other Expenses.
Are you ready to master the basics of Schedule C?
What is Schedule C?
Schedule C is part of your Form 1040 U.S. Individual Income Tax Return. It provides the framework for all of your business income and deductions. You’ll determine your business net income or loss on Schedule C.
In general, individuals who are self-employed, freelancers, or sole proprietors will use Schedule C. There are cases where an LLC (Limited Liability Company) would also use it. See the discussion on LLCs below.
Gather the following information to complete your Schedule C:
- Record of income and expenses for the year
- Receipts, credit card statements, invoices documenting expenses
- Vehicle mileage logs
- Inventory records
Bonus Tip: As a self-employed individual or sole proprietor, you would not pay yourself like an employee. The net profit your business makes already belongs to you. That means you won’t file a W-2 for yourself. Only file W-2s and make Form 941 payroll tax payments for your employees, not for yourself. You can transfer your profits from your business bank account to your personal bank account whenever you like.
Single Person Business Registered as LLC
Like larger businesses, an individual can register with the state to be classified as a limited liability company (LLC). In general, the purpose of registering to become an LLC is to separate personally owned property from business property to protect it from business debts and lawsuits. It’s similar to the protection offered by incorporating your business but easier to operate.
An individual registered as an LLC will automatically be treated like any other solo-owned business unless the individual elects to be treated as a corporation for tax return purposes. You would need to complete Form 8832 for this election.
If you have yet to elect or do not intend to elect to be treated as a corporation, your LLC will file a Schedule C rather than Form 1120 or 1120S. Those are entirely separate returns from a Form 1040 return.
Business Co-owned by Married Couple Using Schedule C
A married couple that owns and operates a business together will initially be considered a partnership by the IRS. The disadvantage of this is the required filing of both Form 1065 Return of Partnership Income and Form 1040 U.S. Individual Income Tax Return. A couple who would like to avoid this additional return can elect to file as a qualified joint venture. That will eliminate the need to file Form 1065 but require the completion of Schedule C for each spouse to be added to Form 1040.
Some requirements need to be met to elect to be treated as a qualified joint venture.
- Each spouse must materially participate in the operation of the business
- There are no other business owners
- File Form 1040 using the married filing jointly status for the tax year
Making the election is simple. Complete a Schedule C for each spouse, including their share of business income and deductions. However, the election only remains effective as long as you and your spouse meet the requirements.
See the following example for completing Schedule C for each spouse:
Jamie and Dale are married and own a part-time catering business together. Each spouse owns a 50% interest in the business. They want to avoid filing a partnership return, and they meet all the requirements to be treated as a qualified joint venture. Their catering business income is $20,000, and business expenses total $12,000. On each spouse’s Schedule C, the income reported will be $10,000, and the expenses will be $6,000, so the net income will be $4,000. The total is $8,000 for the couple’s catering business income on their married filing jointly Form 1040 tax return.
Bonus Tip: If you live in a state with community property laws, you and your spouse can already treat your unincorporated business as a sole proprietorship instead of a partnership. You don’t have to elect to be treated as a Qualified Joint Venture. When you both participate in the business, you’ll split income and expenses on two separate Schedules C, as the example above demonstrates.
Who Would Not Use Schedule C?
It’s important to understand that not all business types will report income and expenses on Schedule C. The following business types would use other forms or returns:
- Corporations – 1120 or 1120S tax return
- Partnerships – 1065 tax return
- Rental property income (in most cases)- Schedule E
- K-1 income – Schedule E
- Farm income – Schedule F
- Activities that do not have the purpose of making a profit
- Hobby income
Differences Among Schedules C, E, and F
Schedule C is one of several business forms that may be required with the Form 1040 tax return. Schedule E and Schedule F are also used to report certain types of business income. Understanding their differences is essential to ensure you use the correct form.
Schedule C Profit or Loss From Business reports income and expenses when you actively participate in a business by providing services or creating goods. Examples of some active participation businesses are driving for Uber, selling items on Etsy, freelancing as a photographer or writer, operating a bakery, or providing catering services.
Schedule E Supplemental Income and Loss is used when reporting rental real estate income, royalty income, partnership and S Corporation income, and other types of passive income.
Schedule F Profit or Loss From Farming is used to report income from the sale of products you raised on your farm, ranch, orchard, or ornamental plant nursery.
Schedule C Details
Let’s face it- most people will fill out their tax return and all its companion forms by using online do-it-yourself software or hiring a tax professional. A step-by-step guide to filling out Schedule C may be unnecessary. Still, it helps to have some guidance to understand everything required for its completion.
Business Information
Principal business activity description: Describe the business activity and provide the type of customer you serve to clarify your business. You will also describe your product or service. This description may impact acceptable business expense deductions you’re allowed to claim.
Business code: This is a six-digit code from the Principal Business or Professional Activities code chart. Most tax return software vendors will provide access to or link to the chart in their software. However, it’s available in the Schedule C instructions. You’ll select the code that best describes your business.
Business name: If you have one, you’ll provide your “doing business as” name here. Not all freelance or solo entrepreneurs have a registered name for their businesses. In that case, your business name will be your name.
Accounting method: This tells the IRS about your accounting method. You’ve likely been keeping accounting records or books for the year, so you’ll check the appropriate box. For a more in-depth look at cash and accrual accounting methods, see “How to Choose the Best Accounting Method: Cash vs. Accrual.”
Material participation: You can learn more about material participation by reading “Understanding Material Participation.”
Filing Forms 1099: While there are many Forms 1099 listed in the IRS’s “Guide to Information Returns,” someone filing a Schedule C who works as a freelancer or self-employed individual will likely need to be concerned with filing Form 1099-NEC Nonemployee Compensation. This information return is used to report amounts paid to individuals who have done work for your business but are not your employees. Any amounts paid over $600 will require a Form 1099-NEC to be filed with the IRS and provided to the contract worker by January 31. It must be available so the contract worker can file their tax return.
It might be helpful to take a look at the complete guide, so you’ll be familiar with any other information forms you may be responsible for filing.
Income
Gross income from your primary business activity goes on Schedule C. When business activity income is paid to you by another business, they may report that income to you and the IRS on certain forms:
- Form 1099-NEC Nonemployee Compensation – income paid by another business for your services that exceeds $600
- Form 1099-K Payment Card and Third-Party Network Transactions – income paid by payment settlement companies (e.g., Etsy, PayPal, etc.) that exceeds $600 for 2023 ($20,000 or 200 transactions for prior years). Some states have lower thresholds.
- 1099-Misc – rent, prizes, other income, fishing boat proceeds, proceeds paid to an attorney, etc., that exceeds $600
- Form W-2 – statutory employee income
Since not all of your business income will necessarily be reported on these forms, you must keep accurate records of all income your business produces.
To keep accurate records, you’ll include all income for your business in your accounting books whether or not you receive a Form 1099.
Bonus Tip: Sometimes, the tax software you’re using will ask separately for Form 1099-NEC, Form 1099-Misc, Form 1099-K, and W-2 statutory employee information. Be aware of the income reported on these forms that you may have previously entered into the software based on your bookkeeping income. You might enter the same income twice and unintentionally report duplicate income.
Always review a PDF of your tax return’s Schedule C to ensure your business income is correct. You can contact your software company’s support team to help you understand how to enter your business income if you encounter a problem.
Expenses
Here’s the best part about being in business for yourself: now, you can deduct all those related business costs!
Schedule C provides specific categories for your business expenses. Any expenses that don’t belong in the categories provided can be entered as “Other expenses.” However, it’s best practice to use specific categories when you can.
Maintain accurate records of your expenses. Keep copies of receipts, credit card statements, invoices, mileage logs, and any third-party documents proving you incurred and paid those business expenses. You won’t need to send them in with your tax return, but the IRS can send a letter requesting documents supporting your deductions. They also have the option to conduct an in-person audit.
Shared Expenses: Personal and Business
It’s possible to pay for services or purchase items you use in both your business and personal life.
For instance, this might apply to a cell phone. As a solo entrepreneur or for any startup business, having a separate phone for business might not make sense. When using the same phone for business and personal, you will determine the amount of total business use and deduct that portion of the total cost as a business expense.
Example:
Your monthly cell phone service bill is $70 or $840 for the year. You’ve determined that 10% of all your calls, texts, and data downloads are related to business. Your annual cell phone business deduction will be $84 ($840 x .10).
It’s possible to pay for services or purchase items you use in both your business and personal life.
For instance, this might apply to a cell phone. As a solo entrepreneur or for any startup business, having a separate phone for business might not make sense. When using the same phone for business and personal, you will determine the amount of total business use and deduct that portion of the total cost as a business expense.
Example:
Your monthly cell phone service bill is $70 or $840 for the year. You’ve determined that 10% of all your calls, texts, and data downloads are related to business. Your annual cell phone business deduction will be $84 ($840 x .10).
Depreciation, Vehicle and Business Use of Home Expenses
Depreciation, vehicle, and business use of home expenses deserve a more detailed look than will be covered here. Those topics will be covered in future articles.
Inventory and Cost of Goods Sold Expense
You may have a business where you sell items you’ve made or resell items that someone else made. You’ll likely want to keep an inventory record. When you sell an item, the amount you invested in the item, basically its cost, will be deducted from the sales price. That’s going to be your profit before other expenses are deducted. That information is necessary for determining your taxable income. Otherwise, you’ll be paying higher taxes than you should.
Cost of Goods Sold
Cost of goods sold is the expense of items you produce or purchase and then sell. To calculate this expense, you would record inventory items as they are bought or made and then record when they are sold. This allows you to match the cost of those inventory items to the income you receive for selling them, thus giving you a more accurate picture of your income or loss for the year.
Example:
Joe has a business where he purchases porch rockers and resells them at his local flea market.
Inventory Record
Beginning-of-year inventory: $1,500
Purchases during year: $1,000
End-of-year inventory: $500
Cost of goods sold: ($1,500 + $1,000) – $500 = $2,000
If Joe’s total sales for the year were $5,000, his profit before other expenses would be $5,000 – $2,000 = $3,000.
Cost of Goods Sold Expense or Supplies Expense
There’s a much simpler alternative available to small businesses. Rather than keeping an inventory record, the inventory items for resell can be treated as a supplies expense. As expected, there are a few rules that cover this method:
- You must own a small business with an average annual income of $27 million (as of the writing of this article) or less for the prior three years. Yep – $27 million! Most sole proprietors meet that criterion.
- You must take the deduction in the year the inventory items are sold to a customer.
- You can only take one deduction for inventory sold. Once items are deducted as supplies, you will not deduct them as cost of goods sold expense too.
- You can only switch between the cost of goods sold method and supplies method from one year to another if you file Form 3115, Application for Change in Accounting Method.
Net Income or Loss
Once you’ve added all your income and business expenses for your Schedule C, the tax software will calculate your net income or loss for your tax return. The net income or loss will be reported on Schedule 1 for Form 1040 U.S. Individual Income Tax Return as Business income or (loss). You’ll file Schedule C with your tax return. This should all be done automatically by the tax software you or your tax professional use.
Conclusion
Now you understand the basics of Schedule C, Profit or Loss From Business. As a dedicated sole proprietor, Schedule C is the business income or loss framework for your Form 1040, U.S. Individual Income Tax Return. Whether you do your tax return using online software or work with a tax professional, you’re ready to begin work on your Schedule C.
