Understanding Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship)

Understanding Schedule C tax guide was developed by Metro Accounting And Tax Services, CPAs  in an effort to help Small Business Owners stay on top of all their accounting and tax needs.

In this guide, we will address how to calculate gross profit and gross income, show you how to identify and deduct expenses, and how to calculate net profit or loss. If help is needed by the small business owner in relation to any accounting or tax needs, our office can be reached at 404-990-3365. Our goal is to help you to focus on running your business and pay the least amount of taxes legally possible.

Understanding Schedule C: Introduction.

To complete a Schedule C the tax payer is required firstly to fill in standard information about themselves and their business. Information required includes: name of proprietor, social security number, principal business or profession – this is basically a description of the type of business you are in, business name, business address and the business employer ID number or EIN.  The tax payer will also notice that there’s a place to enter a Principal Business or Professional Activity Code. These codes are based on the North American Industry Classification System, and the Schedule C instructions contain a list of the six-digit codes relating to business trades or professions.

Next the tax payer will decide on the accounting method used by the business, cash – meaning that income and expenses are only recognized when received or paid, or the accrual method – this is where income and expenses are recognized when they are incurred by the tax payer rather than when they are received or paid. For example, let’s say your power bill for March is not paid until April.  Under the cash method of accounting, the tax payer would recognize and account for the bill when paid in April, however under the accrual method of account the bill would be recognized and accounted for in March even though it was not paid until April. The other questions in this section would be answered accordingly by the tax payer.

Understanding Schedule C: Part I, Income.

The first term we’re going to talk about is Gross Receipts. Gross Receipts are the income that a business receives from the sale of its products or services.

The second term is Returns and Allowances. Returns and Allowances include cash or credit refunds the business   makes to customers, this include rebates and other allowances off the actual sales price. Individuals who don’t make or buy products for resale as part of their business wouldn’t have returns or allowances to deduct from gross sales.

The third term is Cost of Goods Sold. Cost of Goods Sold is the cost to a business to buy or to make the product that is sold. It is easy to calculate the cost of goods sold if you sell all your merchandise during the same year when they were purchased. However, some of your sales will probably be from inventory that you carried over from earlier years and you will probably have inventory left unsold at the end of the year.

To calculate the cost of goods sold you will start with the cost of the inventory on hand at the beginning of the year. You will add the cost of additional goods purchased or manufactured during the year. The cost of any merchandise withdrawn for personal use such as food a grocer may take home or gasoline a garage owner may give to his relatives is then subtracted. This results in the cost of items available for sale during the year. The value of your inventory at the end of the year is then substracted. Your cost of goods sold is the remaining amount.

Some businesses may choose to keep a continuous or automated inventory record for reordering stock. But no matter what type of system you have in place, the tax payer must keep good beginning and year-end inventory records.

The fourth term is Gross Profit. To calculate Gross Profit, first subtract the returns and allowances from total gross receipts. Then, subtract the cost of goods sold from that difference.

The final term for this section is Gross Income. Gross Income is simply the sum of gross profit and other income received during the period.

Understanding Schedule C Part II, Expenses.

According to the IRS, a tax payer can only consider the day-to-day ordinary and necessary business expenses incurred in running his or her business. As of such, expenses must be considered ordinary and necessary in order to be deducted for tax purposes.

The first expense we are going to discuss is car and truck expense. If a taxpayer uses a car for business only the full cost of operating it may be deducted. If the taxpayer uses the car for both business and personal purposes, the expenses must be divided between both uses on the basis of mileage to compute a business percentage.

If the taxpayer claims any car or truck expenses, additional information pertaining to such use must be provided on Schedule C, Part IV, Information on Your Vehicle. Please note that the taxpayer is only required to complete this part if car or truck expenses are entered on line 9 of Schedule C and the taxpayer is not required to file Form 4562, Depreciation and Amortization.

It is important to note that the taxpayer should not include commuting miles to and from work as business mileage. You may take a deduction for your actual business expenses for the car or use a standard mileage rate. Standard mileage means multiplying your business mileage by the IRS standard rate. Actual business expenses include gas, oil, repairs, insurance, depreciation, tires, and license plates. Under either method, parking fees and tolls are deductible

The second expense is depreciation. Depreciation is the annual deduction allowed to recover the cost, or other basis of business, or investment property having a useful life substantially beyond the tax year. Depreciation starts when you first use the property in your business for the production of income, and it ends when you take the property out of service, deduct all your depreciable cost, or other basis, or no longer use the property in your business.

Of importance to the tax payer is the fact that land, inventory, or property placed in service and disposed of in the same year are not depreciated.

Depreciation Methods

There are two main methods to calculate depreciation: They are the Modified Accelerated Cost Recovery System and the Section 179 deduction.

For most tangible property, that is, properties you can see or touch, the acceptable depreciation method is the Modified Accelerated Cost Recovery System. It’s commonly referred to by its initials, MACRS, and pronounced “makers.”

For the other method, under Section 179 of the Internal Revenue Code, you can elect to recover all or parts of the costs of certain qualifying property, up to a limit, by deducting it in the year you place the property in service.

The third and fourth expenses up for discussion are those for legal, professional services and office expenses incurred by the taxpayer in running their business. Included in these expenses are fees charged by accountants and attorneys that are ordinary and necessary expenses directly related to the operating of the business. Also included are fees for tax advice related to the business and for preparation of the income tax return and the various forms related the business. In addition, under the category of office expense, office supplies and postage are also included.

The fifth expense that is of importance to the small business owner is the supplies expense. In most cases, a taxpayer can deduct the cost of materials and supplies only to the extent they were actually consumed and used by the business during the tax year, unless they were deducted in a prior tax year. You can also deduct the cost of books, professional instruments, equipment, etc., if you normally use them within a year.

If their usefulness, however, extends substantially beyond a year, you must generally recover their costs through depreciation.

Next up is the travel, meals, and entertainment expenses. For the travel part of these expenses, the taxpayer is allowed to deduct expenses for lodging and transportation connected with overnight travel for business while away from your tax home. This is simply the main place of business, regardless of where you maintain your family home.

For the meals and entertainment expenses the taxpayer would enter the total deductible business meal and entertainment expenses. This includes expenses for meals while traveling away from home for business and any meals that are business-related entertainment. Business meal expenses are deductible only if they are directly related to or associated with the active conduct of your trade or business; not lavish or extravagant; and incurred while you or your employee is present at the meal.

After you’ve completed entering your individual expenses, add them up and enter them as your Total Expenses. If you run your business out of your home, don’t forget to enter those expenses, too. This is done a few lines down.

Next, you have to enter your Net Profit or Loss. Net Profit or Loss is the amount by which the gross profit and any other income for a period is more, or less in the case of a loss, than the business expenses and depreciation for the same period.

To calculate net profit or loss, the tax payer would subtract from the gross profit the total expenses incurred and any expenses for the business use of your home.  The tax payer would then report this profit or loss on line 12 of Form 1040, U.S. Individual Income Tax Return.

Completing the Schedule C can be a bit challenging at times, but doing so accurately can have a big impact on your tax refund. The Certified Public Accountants at Metro Accounting and Tax Services are ready to take this weight off your shoulders. Don’t hesitate to contact the office for all your accounting and tax needs.

User | 16/01/2018