This article has been reviewed by tax expert Erica Gellerman, CPA.
If your business is a sole proprietorship, or if you’re self employed, you must complete a Schedule C tax form each year as part of your tax filing process. The IRS Schedule C is used to determine the taxable profit in your business during the tax year. You then report this profit on your personal 1040 Form and calculate the taxes due from there.
Although the Schedule C form is one of the easier tax forms to understand and complete, you might find completing it for the first time a little daunting. Even if you use the services of a tax professional, you still need to understand how to complete Schedule C to ensure the accuracy of your tax filing information.
The IRS provides detailed, line-by-line instructions for completing the Schedule C tax form, so we won’t duplicate that here. But that’s not always the most helpful for everyone, so what we’ve outlined here is a step-by-step walkthrough of Schedule C instructions, written in plain English.
A quick glance:
The first step in your Schedule C instructions is to compile some information. This includes:
1. The IRS’s instructions for Schedule C. Even if the rest of the IRS Schedule C form looks straightforward enough that you don’t think you’ll need instructions, you’re still going to need the Principal Business or Professional Activity code for your business. This is conveniently located within the IRS’s instructions.
2. Your employer identification number (EIN). If you have a separate EIN for your business, you must include it on your Schedule C. If you haven’t memorized your EIN, you can find it on the IRS notice you receive after submitting your Form SS-4 to the IRS.
3. Profit and loss statement for the tax year. Schedule C is a reporting of the profit or loss in your business. You can find most of the information you need to complete your Schedule C tax form on the profit and loss statement or income statement from your bookkeeping software. Make sure you’re using the correct basis (most small businesses file their tax returns on a cash basis.)
4. Inventory count and valuation as of the end of the tax year. If you sell items in your business, you need to determine the cost of the goods you sold during the tax year. Conduct an annual physical inventory in your business to validate the information in your point of sale or other inventory management software before completing your IRS Schedule C.
5. Mileage records. If you use your personal vehicle for your business, you must keep mileage records to deduct the expenses for the business use of your vehicle. Avoid the temptation to “estimate” your mileage. There are a number of good smartphone apps you can use to track your mileage, or you can keep a paper mileage log.
If you have the information above compiled, completed, and ready, then you’re set to move on to completing your Schedule C tax form. You can find a fillable PDF of the form on the IRS’s website or you can use tax preparation software to complete your IRS Schedule C. Whichever approach you choose, your Schedule C form will look the same—and all of these steps apply.
The top part of IRS Schedule C doesn’t have a section header or a name, but it is still important. Following these Schedule C instructions, the top part of the form is where you’ll enter:
The Schedule C instructions for Part I is to report the income in your business. It’s also where you calculate your gross profit and your gross income.
Your business expenses reduce the profit in your business, and—with regard to taxes—less profit is desirable because it means a lower tax liability. This does not mean you should incur unnecessary expenses just to avoid paying taxes. You ultimately want a profitable business, but, as you follow these Schedule C instructions, be sure you are capturing all your qualified business expenses on your IRS Schedule C tax form.
Most of the fields in Part II are self-explanatory, and you can pull the numbers you need from your Profit and Loss statement. Most business owners will have expense categories on their P&L that don’t directly tie to any one of Lines 8 – 27a. You can use Part V of Schedule C to capture these expenses.
There are a few lines in Part II that require more in-depth explanation, though:
Hang in there… we’re almost done! You’ll use Part III of the Schedule C tax form if you sell products or use subcontractors to generate income in your business.
Most of the lines in Part III are straightforward. You can pull the amounts required directly from your P&L or point of sale system, or make a simple calculation to arrive at the necessary subtotals. When following these Schedule C instructions, make sure you don’t include any expenses included in Part II.
Line 33 warrants a little additional explanation. On this line, you will state your inventory valuation method. Most small businesses use the “Cost” inventory valuation method, as it is the least complicated. The other option listed is “lower of cost or market.” This means you’re valuing your inventory at either the historical cost or the current market value, whichever is lower. If you change how you account for inventory, you’ll need to file Form 3115.
If you’re claiming vehicle expenses on Line 9, you have to complete Part IV of Schedule C.
This is where you’ll use the mileage records mentioned earlier in this article. Again, don’t be tempted to estimate or guess at this information. In the event of an audit, you’ll be required to provide evidence your vehicle expense deduction is valid, so keep your mileage records in a safe place.
Part V is the section of Schedule C used to capture the expenses you didn’t report on Lines 8 through 26 or Line 30. Remember, you are allowed by law to deduct all legitimate business expenses from your income to reduce your taxable profit. Don’t skip an expense just because it doesn’t have a specific line number in Part II. List the expense in Part V, and the enter the total of all lines in Part V on Line 27a.
Whew! If you’ve effectively followed these Schedule C instructions, your IRS Schedule C form should now be complete.
Before you enter the profit or loss on Line 31 onto your Form 1040, take a few minutes to review your IRS Schedule C and double check your calculations one more time. Or, if your accountant has prepared your tax return for you, compare your IRS Schedule C with your P&L for the tax year. Your accountant will be happy to answer any questions you have, so you can be sure you’re filing the most accurate tax return you can.
Billie Anne Grigg is a contributing writer for Fundera.
Billie Anne has been a bookkeeper since before the turn of the century. She is a QuickBooks Online ProAdvisor, LivePlan Expert Advisor, FreshBooks Certified Beancounter, and a Mastery Level Certified Profit First Professional. She is also a guide for the Profit First Professionals organization.
Billie Anne started Pocket Protector Bookkeeping in 2012 to provide an excellent virtual bookkeeping and managerial accounting solution for small businesses that cannot yet justify employing a full-time, in-house bookkeeping staff.