Reporting Business Income or Loss on Schedule C and Form 1040
Schedule C calculates your net business income or loss
Taxpayers who earn income from a business, from freelancing, or from working as independent contractors are considered by the IRS to be self-employed.
This means that your tax situation will become a bit more complicated if you've decided to leave your regular job and go out on your own, or even if you keep working your regular job but you're picking up extra income doing some work on the side. You can be self-employed according to the tax code even if you're also earning wages or a salary from an employer.
You must report your business income and expenses by filing at least one additional tax document, IRS Schedule C. This is a calculation worksheet known as the "Profit or Loss From Business" statement. It's where you'll tally up and enter all the income you earned from your self-employment efforts during the year and deduct your allowable business expenses
What Counts as Business Income?
Technically, business income is anything you earn because you own and operate a business. The IRS explains it this way:
"If there is a connection between any income you receive and your business, the income is business income. A connection exists if it is clear that the payment of income would not have been made if you did not have the business." (Publication 334)
Business income includes:
- Income received for services rendered as an independent contractor, freelancer, or other non-employee position
- Income received for manufacturing or selling merchandise
- Income received from government contracts
- The fair market value of property or services received through bartering
Business income does not include income earned from employment and reported on Form W-2 if you also hold down a regular job. This goes in a separate place on your tax return, even if the job you do for your employer and the work you do on your own is the same.
For example, maybe you're an electrician by trade, you work for an electrical contractor, and you also service your own customers on the weekend.
Your W-2 income is not considered business income. It's wages, reported elsewhere on your tax return.
Reporting Self-Employment Income
Many sole proprietors receive 1099-MISC forms from their customers or clients showing exactly how much they were paid by that entity. In theory, this makes calculating your income pretty easy, but in reality, there are a few more things to consider.
Your clients and customers are only required to file 1099-MISC forms with the IRS and furnish you with copies when they pay you more than $600 during the tax year. This doesn't mean that anything less is not taxable income to you. It just means that the client was not subject to IRS reporting requirements. You still have to include this money in your income on Schedule C.
Form 1099-MISC also reports royalties earned of $10 or more.
Form 1099-MISC reports your aggregate earnings from any one client. You would receive one if you were paid $300 in June and $301 in December, even though neither payment topped the $600 reporting requirement. They payments met the requirement when added together.
You have to report cash payments as income as well. You earned it, after all. It's unlikely anyone would consider it necessary to issue you a 1099 if they paid you in cash, no matter how much the amount, so you'll have to keep careful records throughout the year to avoid losing track of these sums. Cash payments don't mean the money was invisible or didn't change hands.
Reporting Business Expenses
You can subtract your business expenses on Schedule C as well after you enter the total of your business income. These are defined as expenses that are "ordinary and necessary" for conducting your business—more tax code lingo.
Ordinary essentially means that just about everyone else in your line of business also spends on this same expense. Necessary means that the expense was 'helpful" or "appropriate" to allow you to make money.
If you're an electrician, you'll need certain tools. Their cost is a business expense. Likewise, your mileage is a business expense if you drive to customers' homes or places of business to repair their computer systems. You can't make money in your field without first spending it on these things.
You might maintain a home office if you do consulting work. A percentage of your rent or mortgage, utilities, and insurance would count as a business expense proportionate to the portion of your home's total square footage that your office area takes up. You're entitled to deduct a business expense of 10% of your home expenses subject to certain rules if your home is 2,500 square feet and your office area is 250 square feet.
You can also claim things like office supplies and equipment as business expenses. Schedule C lists all your options beginning with Part II on the form. Take time to familiarize yourself with them and set up your accounting software to use the categories that are relevant to your self-employment. This will make it much easier for you to complete Schedule C at tax time.
Schedule C also includes Part III for calculating "Cost of Goods Sold." This is for use if your business purchases items for resale or manufacture items for sale. The cost is also deductible from your total business revenues.
Using the Shorter Schedule C-EZ
Some self-employed taxpayers can use the shorter and easier Schedule C-EZ to report their business income and expenses. They'll qualify if their total expenses are $5,000 or less, if they used the cash method of accounting, if they held no inventory at any time during the tax year, and if they had only one business.
You must use the longer Schedule C if your expenses are more than $5,000, if you're reporting a loss because your expenses were greater than your income, or if you don't meet one or more of the other rules.
Whichever form you use, you must attach it to your 1040 tax return when you file it.
How to Enter Your Schedule C Total
Schedule C will calculate your net business income or loss after you add in all your income and subtract all your expenses. You must report this number on line 12 of Schedule 1, "Additional Income and Adjustments to Income." Schedule 1 accompanies your Form 1040 tax return. You'll then add the total income you arrive at by completing Schedule 1 on line 7b of the 2019 Form 1040.
Forms 1040 from tax year 2018 and later are somewhat unique, and these lines do not apply to tax returns from earlier years. The IRS totally revamped the 1040 return to streamline it with several provisions of 2018's Tax Cuts and Jobs Act. They are markedly different from tax returns used in tax years 2017 and earlier.