19.2 Schedule C and Self-Employment Income

Schedule C is a crucial form for self-employed individuals and small business owners. It's where you report your business income and expenses, helping you calculate your net profit or loss. This form is a key part of your tax return, directly impacting your overall tax liability.

Understanding Schedule C is essential for accurate income reporting and maximizing deductions. From gross receipts to allowable expenses, it covers all aspects of your business finances. Proper completion ensures you're paying the right amount of taxes and avoiding potential IRS scrutiny.

Income and Expenses on Schedule C

Purpose and Components of Schedule C

• Schedule C (Form 1040) reports income or loss from sole proprietorships or single-member LLCs
• Gross receipts or sales encompass all business income (cash, checks, credit card payments)
• Common business expenses include advertising, vehicle expenses, depreciation, insurance, office expenses, and wages
• IRS mandates expenses be ordinary and necessary for Schedule C deductibility
• Home office expenses claimable if space used exclusively and regularly for business

Specialized Expense Reporting

• Cost of goods sold reported for businesses manufacturing products or purchasing goods for resale
• Meal and entertainment expenses subject to specific deductibility limitations
• Depreciation of business assets calculated and included as an expense
• Inventory valuation methods (FIFO, LIFO) impact cost of goods sold for businesses with inventory

Calculating Net Profit or Loss

Income and Expense Recognition

• Net profit or loss calculated by subtracting total expenses from gross income on Schedule C
• Gross income includes all business revenue streams (sales, commissions, service fees)
• Total expenses sum all allowable business deductions on Schedule C
• Cash or accrual accounting methods affect timing of income and expense recognition
• Net operating losses from Schedule C carried forward to offset future business income

Accounting Methods and Inventory Valuation

• Cash method recognizes income when received and expenses when paid
• Accrual method recognizes income when earned and expenses when incurred
• FIFO (First-In, First-Out) assumes oldest inventory sold first
• LIFO (Last-In, First-Out) assumes newest inventory sold first
• Average cost method uses weighted average of all units available for sale

Reporting Self-Employment Income

Form 1040 Reporting Requirements

• Schedule C net profit or loss reported on Schedule 1 of Form 1040
• Schedule SE filed to calculate self-employment tax if net earnings $400 or more
• Separate Schedule C required for each distinct business activity
• Qualified Business Income (QBI) from Schedule C may qualify for Section 199A deduction on Form 1040
• Estimated tax payments reported on Form 1040-ES throughout the year

Additional Reporting Considerations

• Form 4562 attached to report depreciation and amortization expenses
• Statutory employees report income on Schedule C but exempt from self-employment tax
• Schedule C-EZ available for simplified reporting if business expenses $5,000 or less
• Form 8829 used to calculate home office deduction if applicable

Self-Employment Tax Obligations

Self-Employment Tax Calculation

• Self-employment tax comprises Social Security (12.4%) and Medicare (2.9%) taxes, totaling 15.3%
• Calculated on 92.35% of net earnings from self-employment
• Schedule SE used to compute self-employment tax, reported on Schedule 2 of Form 1040
• Social Security portion applies only to earnings up to annual wage base limit ($142,800 for 2021)
• Additional 0.9% Medicare tax on self-employment income above certain thresholds (200,000 single, $250,000 married filing jointly)

Tax Deductions and Reporting

• Employer-equivalent portion (50%) of self-employment tax deductible on Form 1040 as adjustment to income
• Self-employed health insurance premiums potentially deductible on Form 1040
• Retirement contributions (SEP IRA, Solo 401(k)) may reduce self-employment tax liability
• Form 1040-ES used to calculate and pay quarterly estimated taxes