There are many different income tax forms businesses and self-employed individuals must know. However, one of the more important ones is Schedule C, which is used by every business. The Schedule C tax form reflects a business’s or individual’s self-employment tax income/expenses and is included with each 1040 return. It’s also similar to another important business form called the income statement.
They’re similar because the simple equation for both is revenue-expenses=profit.
However, Schedule C records annual income/expenses, while income statements amounts change throughout the year. This article will serve as a guide to Schedule C preparation, special tips, and mistakes to avoid.
What is the Schedule C Tax Form?
As noted earlier, Schedule C is used to record self-employment at tax time. Therefore, it’s wise that a business or self-employed individual keeps accurate records to ensure precision. Also, it’s suggested to create and maintain an income statement throughout the year as it’s similar to Schedule C.
Each aggregate tax return is referred to as a 1040, after form 1040, which is a two-page cover form that summarizes every schedule. Some other common schedules include Schedule A (major personal pre-tax deductions), Schedule B (interest/dividend income) and Schedule D (short/long term capital gains income).
Each business must file this form if its goal is to generate profit and it’s regularly involved in business activities. Also, it must be submitted by the tax deadline each year which falls around April 15. If April 15 falls on a weekend, then it can be extended by a day or two, just be sure to check the IRS calendar here.
Luckily, popular tax software like Turbo Tax can help businesses accurately calculate and electronically submit the Schedule C tax form. This software also gives businesses the option to consult with a pre-vetted CPA, which could help ensure accuracy.
Lastly, single business members that had less than $5,000 in business expenses have the option to use a simplified version called Schedule C-EZ. Schedule C-EZ is very basic as it only accounts for gross income, expenses, profit, meal and vehicle deductions.
Detailed Schedule C Tax Form layout
The first areas to fill out include basic contact info, business codes, and accounting method. Using basic info like EIN, addresses, and business type are straightforward, while specific codes along with accounting methods require more thought. Luckily, the IRS has provided a comprehensive list of business codes, which are used to accurately describe business functions.
Properly choosing either the cash or accrual accounting method is imperative for filling out this form correctly. The cash method records income and expenses when cash changes hands. Conversely, the more frequently used accrual method records income when it’s earned and expenses that are billed.
For example, accrual accounting would recognize revenue billed in December in that month. On the other hand, cash accounting would record income when the cash was received the following January. Lastly, accrual accounting uses both the accounts receivable and accounts payable line items, which record future revenue and expenses respectively.
More important administration functions
Before diving into the income and expenses, each business or self-employed individual must clarify a few administrative functions. These functions include conforming with the 7 material participation rules and recording independent contractor payouts. The business material participation rules determine if an individual plays an active part in running a business.
These rules can be found on the IRS website and serve to weed out investors who sit in on board meetings along with taxpayers that have income producing hobbies. Most of the rules describe time commitment details like the need to participate in the business for at least 500 hours out of the year.
Hobby loss rules are important as taxpayers can’t deduct a hobby loss. Conversely, investors can deduct a net income loss if it’s determined to be business income. Some income producing hobbies include glassmaking, selling on Etsy and baking cupcakes. The main differences between businesses and hobbies include profit intentions, time commitment, bookkeeping and depending on the income for livelihood. Hobby loss rules can be complex and can blur tax rules as side hustles are becoming more popular.
Another important item to record on the Schedule C tax form is contractor payouts. Many businesses hire independent contractors on a per project basis to complete specialized tasks. These workers aren’t employees, which allows businesses to not withhold nor pay taxes on their behalves.
However, businesses must issue each contractor a form 1099 MISC if they’ve paid him or her more than $600 per year. One copy of form 1099 MISC will be sent to the contractors to help them accurately record earnings on their tax returns and the other copy will be sent to the IRS.
Key income and expenses areas
Once the administrative items are completed, start filling out the income area of the Schedule C tax form.
Gross revenue appears on the first line of this sheet and it accounts for the businesses total product and service revenue throughout the year. It shouldn’t account for any costs required to deliver the products or services. Instead, record these costs under the Cost of Goods Sold (COGS) line item.
COGS account for specific costs like labor costs (payroll expenses), and product expenses like materials, supplies, along with wholesale inventory prices. COGS don’t include advertising and distribution costs as these are recorded in the expense section.
Another important line item is the returns and allowances section, which accounts for any refunded items. This item also includes any items that are sold for reduced costs, like discounts.
This might seem like jargon, but this hypothetical company example should clarify it:
Josh’s Swim Business Simple Schedule C
Gross income $101,000
Returns and allowances $1,000
Total Income: $100,000
Cost of Goods Sold (COGS):
Labor Costs $15,000
Product Costs: $5,000
Total COGS: $20,000
Net Profit: $80,000
There are many expenses not captured in COGS like marketing, shipping, automobile costs and more. Many of these deductions are pretty self-explanatory, yet others aren’t.
For instance, businesses can use line 9 for automobile expenses. The first action to implement is to determine the number of miles driven for business use.
Then, multiply this figure by the 2019 per mile deduction of $0.58 to get the total business miles. Besides business mileage deductions, the IRS also offers taxpayers deductions for miles driven for medical/moving reasons ($0.20) along with charitable purposes ($0.14).
It might seem daunting to keep track of business miles, but apps like MileIQ make it simple. This app allows self-employed individuals to track and calculate business miles with the touch of a button. Businesses can also deduct other vehicle expenses like gas, maintenance, tires, and registration. However, businesses should be aware to prorate business use over personal use to qualify.
For example, if a car is used 70% for business purposes, then the aggregate allowed deduction would the total costs multiplied by 0.70.
Meals and entertainment
Another important, yet misunderstood line item is meals and entertainment deductions. This amount will be recorded on line 24b and allows a 50% deduction for business-related meals. So, if a business treats a client to dinner, half of the meal cost would be deductible. In the past, many businesses would keep receipts of the expenses, which made it hard to track.
Therefore, it’s wise to use tax software like QuickBooks Self Employed to take photos and store receipts. This will make it easy to accurately fill out this line item come tax time. Tax-deductible meals must be business related, not extravagant and the owner or an employee must be present.
Prior to the 2017 Tax and Jobs Act, 50% of entertainment expenses were deductible. Currently, most entertainment deductions are eliminated with the exception of memberships to business-related memberships. So, a financial planner who pays yearly dues to be a CFP can deduct these fees on this entry.
Some other expenses include accounting/legal fees, miscellaneous office expenses, paid interest, and retirement plan contributions. Self-employed taxpayers receive more deductions than employees, which includes those that employees had prior access.
For example, any taxpayer that itemized deductions could write off accounting and legal fees. This would have gone under miscellaneous deductions on Schedule A, which have been mostly eliminated for future tax years.
Another deduction to pay close attention to is the pension/profit sharing deductions on line 19. Many businesses offer profit sharing plans along with standard 401(k)s to entice high performance. This is a smart strategy, but it’s wise to know the fundamentals of these plans like contribution limits.
One mistake that businesses make is excess deferrals over these thresholds. If not corrected, these can lead to unnecessary taxes and compliance headaches. Fortunately, businesses can remove these excess deferrals and avoid penalties if it’s done by April 15. This example also demonstrates why it’s important to stay on taxes throughout the year to avoid unpleasant surprises and understand actual expenses.
There’s a reason depreciation is in its own category as it can be complex. Depreciation is the annual diminishing value of an asset, which gives businesses tax deductions. Depreciation is recorded on line 13 and is split into two major categories: Straight Line and MACRS.
- Straight line allows a business to take the same annual deduction for an asset and its formula is (acquisition cost – salvage value/useful life).
- Conversely, MACRS is more complex and lets businesses take higher initial deductions for certain assets that decrease over time.
Both types of depreciation are based on an asset’s useful life. This refers to the years an asset can be used prior to becoming obsolete. A business that has a copier with an acquisition cost of $10,000, salvage value of $2,000 and a useful life of 4 years, can deduct $2,000/yr. This assumes it uses the straight-line method and certain assets like residential real estate, have predetermined useful lives.
Per MACRS rules, residential real estate’s useful life is 27.5 years. This means that depreciation deductions can be taken for this time period and this table will explain other asset’s useful lives under MACRS. MACRS might seem intimidating, but this calculator will help businesses calculate it correctly.
Another depreciation related concept is called depletion, which refers to the cost of extracting natural resources and is found on line 12. This applies to businesses whose main source of revenue comes from natural resources like oil, gold, and timber. Depletion has many intricate rules, but most business owners don’t have to worry about it.
Biggest Schedule C mistakes to avoid
Schedule C has some straightforward entries, but there are some common pitfalls that should be avoided. Some of the most common and avoidable errors include passive activity loss, real estate professional status, taking deductions on the wrong schedule along with not taking advantage of carryforwards.
The passive activity loss rule especially applies to real estate and non-real estate professionals that receive passive rental real estate income. If a business or an individual receives passive income (i.e rental/royalty income), it must file Schedule E. Sometimes, real estate investors can use items like expenses and depreciation to have deductible losses on paper.
This might seem simple, but it can be tricky depending on whether that person is a real estate professional or not. Real estate professionals can apply uncapped amounts of passive real estate losses against their Schedule C tax form income. Conversely, real estate investors who have day jobs can only deduct up to $25,000 worth of losses against their incomes. The real estate professional status has two main conditions which are:
- The taxpayer materially participates in real estate at least 750 hours per year
- At least half of the business activity is related to real estate
If a business conducts real estate transactions, it would be wise to meet with a tax adviser to help ensure these two critical tests are met.
Taking tax deductions on the wrong schedule
Another critical mistake is incorrectly reporting the types of expenses, which are broken down between personal and business.
Personal expenses would be recorded on schedule A, while business expenses would go on Schedule C. Some individuals would record expenses like unreimbursed employee expenses on Schedule A, which would result in lower tax savings.
Schedule A applies to taxpayers who itemized their deductions instead of using the standard deduction. Taxpayers have the option to take either the higher of the standard deduction or total itemized deductions.
Some common itemized deductions include property taxes, state taxes, and charitable contributions. Also, many of these deductions used to be eliminated or phased out, once a taxpayer becomes a high earner. This would result in the taxpayer receiving lower tax benefits. Conversely, Schedule C income has fewer capped deductions, which allow for greater tax savings.
The 2017 Tax Act and Jobs act greatly reduced the amount of miscellaneous Schedule A deductions along with phase-outs. Despite this, it’s still prudent to properly classify business vs personal expenses to ensure accuracy. This IRS guide will help define these categories in great detail.
Not factoring carryforward benefits
Carryforward benefits refer to losses that can be used in future years. Capital Gain carryforwards are a common example. Currently, taxpayers can deduct up to $3,000 per year in capital gain losses, with the remainder being carry forwarded to future years. Missing out on these carryforward losses can result in unnecessary taxes.
However, most Schedule C tax form losses are deductible in the same year, with the exception of net operating loss (NOL). NOL allows businesses to have carryover deductions, that are either the lesser of the available NOL carryover or 80 percent of pre-NOL deduction taxable income.
This example will help clarify it:
Josh’s Swim Company has a $50,000 total NOL from 2017 and prior tax years. This company generated $100,000 in NOL in 2018 and is on track to have a 2019 taxable income of $100,000. Josh’s Swim Company can use it’s prior $50,000 NOL and $80,000 of the 2018 NOL ($100,000 taxable pre-NOL income multiplied by 0.80).
The Schedule C tax form is one of the most important business tax forms. One man businesses to large corporations should learn how to prepare this form along with its special details. It’s also similar to an income statement, or profit & loss statement since they share this simple formula: revenue-expenses=profit.
Schedule C summarizes the aggregate annual income/expenses, while income statements change throughout the year. In fact, most companies compare their income statements on a quarterly basis. Schedule C can be complex, which is why it’s smart to learn how to prepare it, special tricks, and common mistakes to avoid.
Disclaimer: This article is not tax advice and is used for educational purposes only. Consult a CPA or tax adviser for tax advice.