Reporting Business Income or Loss on Form 1040
Schedule C calculates your net business income or loss
If you've decided to leave your regular job and go out on your own—or even keep working your regular job but pick up extra income by doing some work on the side—your tax situation will become a bit more complicated. Taxpayers who earn income from a business, from freelancing, or from working as independent contractors are considered self-employed under the tax code. This means they have to report their business income and expenses by filing at least one additional tax document, IRS Schedule C.
What Goes on Schedule C?
Schedule C is a calculation worksheet known as the "Profit or Loss from Business" statement. It's where you'll tally up and enter all income you earned from your business efforts during the year.
Many sole proprietors receive 1099-MISC forms from their customers or clients showing exactly how much they were paid. 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 a 1099-MISC form with the IRS and furnish you with a copy when they pay you more than $600. 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.
And what about customers who might have paid you in cash? You have to report that income, too.
You earned it, after all. If they paid you in cash, it's unlikely they'll consider it necessary to issue you a 1099 no matter how much the amount was so you'll have to keep careful records throughout the year to avoid losing track of these sums.
What Counts as Business Income?
Technically, business income is anything you earn because you own and operate a business.
That's the easy answer. 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
- Fair market value of property or services received through bartering
It does not include income earned from employment and reported on Form W-2 if you also hold down a regular job. Even if the job you do for your employer and the work you do on your own is the same—maybe you're an electrician by trade, you work for an electrical contractor, and you also service your own customers on the weekends—your W-2 income is not considered business income. It's wages, reported elsewhere on your tax return.
Reporting Business Expenses
After you enter the total of your business income on Schedule C, you get to subtract your business expenses. These are defined as expenses that are ordinary and necessary for conducting your business.
If you're an electrician, you'll need certain tools. Their cost is a business expense.
If you do consulting work, you might maintain a home office. A portion of your rent or mortgage, utilities, and insurance would count as a business expense proportionate to the percentage of your home's total square footage that your office area takes up. If your home is 2,500 square feet and your office area is 250 square feet, you're entitled to deduct a business expense of 10 percent of your home expenses subject to certain rules.
You can also claim things like office supplies and equipment and business-related mileage 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 business.
This will make it much easier for you to complete Schedule C at tax time.
After you add in all your business income and you subtract all your business expenses, Schedule C will calculate your net business income or loss. This is the number you must report on line 12 of your Form 1040 tax return, "Business Income or Loss."
Using the Shorter Schedule C-EZ
Self-employed business owners can use the shorter Schedule C-EZ to report their business income and expenses if their total business expenses are $5,000 or less. If your expenses are more than $5,000, or if you are reporting a business loss because your expenses were greater than your income, you must use the longer Schedule C. Whichever you use, you must attach it to your tax return when you file it.