Schedule C (Form 1040): Profit or Loss From Business - A Complete Guide (2013)

What Schedule C (Form 1040) Is For

Schedule C is the tax form sole proprietors use to report income and expenses from businesses they own and operate. If you work for yourself—whether you're a freelance writer, independent contractor, small shop owner, consultant, or run any business as the sole owner—this is how you tell the IRS about your business's financial performance for the year.

The form serves multiple purposes beyond simple income reporting. It calculates your actual business profit or loss by allowing you to subtract legitimate business expenses from your gross receipts. This net figure flows to your main Form 1040 tax return and also determines whether you owe self-employment tax (the self-employed person's version of Social Security and Medicare taxes). If you earned $400 or more in net self-employment income, you'll need to complete Schedule SE alongside Schedule C to calculate these additional taxes.

Schedule C also works for statutory employees—people who receive a W-2 with the ""Statutory employee"" box checked—and for certain qualified joint ventures where spouses co-own and operate a business together. The form accommodates various accounting methods, whether you track income when cash changes hands or when you earn and incur obligations.

When You’d Use Schedule C (Including Late or Amended Returns)

Schedule C attaches to your Form 1040 and follows the same filing deadline—typically April 15 of the year following the tax year, though 2013 returns were due April 15, 2014. If you missed that deadline, you should still file as soon as possible. The IRS calculates penalties based on how late you file and how much tax you owe, but filing late is always better than not filing at all.

If you need more time, you can request an automatic six-month extension using Form 4868, which would have moved the 2013 filing deadline to October 15, 2014. However, an extension to file is not an extension to pay—you still owe any taxes by the original April deadline, and interest accrues on unpaid balances.

For amendments, you'll use Form 1040-X (Amended U.S. Individual Income Tax Return) with a corrected Schedule C attached. Common reasons for amending include discovering unreported income, finding receipts for expenses you forgot to claim, or correcting mathematical errors. You generally have three years from the date you filed your original return (or two years from when you paid the tax, whichever is later) to file an amended return and claim a refund. The three-year clock typically starts from the original filing deadline if you filed early.

Key Rules or Details for 2013

Business vs. Hobby

The IRS requires that your activity genuinely operates as a business, meaning your primary purpose is making a profit and you engage in it with continuity and regularity. Sporadic activities or hobbies don't qualify, even if they occasionally generate income. This distinction matters because business losses can offset other income, while hobby expenses cannot exceed hobby income.

Material Participation

Line G asks whether you ""materially participated"" in your business during 2013. This determines whether your business is a passive activity, which affects how you can use losses. You materially participated if you meet any of seven tests—the simplest being that you worked more than 500 hours in the business during the year. Most sole proprietors who actively run their own businesses will check ""Yes"" here.

Accounting Methods

You must choose between cash and accrual accounting. Cash method (the simpler option) means you report income when you actually receive payment and deduct expenses when you actually pay them. Accrual method means you report income when you earn it (even if not yet paid) and deduct expenses when you incur them (even if not yet paid). Most small businesses use cash accounting unless they maintain inventory for resale.

Inventory Capitalization

If you buy products to resell or manufacture goods, you cannot deduct the full purchase cost immediately. Instead, these costs must be capitalized into inventory, and you only deduct them as ""cost of goods sold"" when you actually sell the items. Part III of Schedule C walks you through this calculation.

Information Returns

If you paid anyone $600 or more during the year for services (like contract labor, rent, or professional fees), you generally must file Form 1099-MISC to report those payments. Line I specifically asks whether you made such payments and whether you filed the required forms.

Step-by-Step (High Level)

Part I – Income

Start by entering your gross receipts or sales on line 1—the total amount customers paid you before any expenses. If you maintain inventory, complete Part III first to calculate your cost of goods sold (line 4), which you subtract from gross receipts to get gross profit (line 5). Add any other business income on line 6 (such as refunds, prizes, or miscellaneous income), and you have your total gross income on line 7.

Part II – Expenses

Lines 8 through 27 list specific expense categories where you enter costs directly related to operating your business. Common expenses include advertising, car and truck expenses, supplies, rent, utilities, insurance, legal and professional services, and office expenses. The form provides dedicated lines for frequent expenses and a catch-all ""Other expenses"" section (Part V) for less common costs. Remember that expenses must be both ordinary (common in your industry) and necessary (helpful and appropriate for your business).

Vehicle Expenses

For 2013, you can use the standard mileage rate of 56.5 cents per business mile driven, or you can deduct actual expenses (gas, repairs, depreciation, etc.) based on the business-use percentage of your vehicle. Part IV collects information about your vehicle use to substantiate your deduction.

Depreciation and Section 179

Line 13 is where you claim depreciation on property you use in your business—spreading the cost of assets like equipment, computers, or furniture over multiple years. You may also elect under Section 179 to immediately expense (rather than depreciate) a portion of qualifying property purchased in 2013. You must complete Form 4562 if claiming depreciation on assets placed in service during 2013, claiming Section 179 expensing, or reporting listed property.

Business Use of Home

Line 30 is for home office expenses. You can only deduct these if you use part of your home exclusively and regularly as your principal place of business or as a place to meet clients. For 2013, the IRS introduced a simplified method allowing you to deduct $5 per square foot of home office space (up to 300 square feet), or you can use the more complex actual-expense method with Form 8829.

Calculating Net Profit or Loss

Line 28 totals all your expenses. Subtract this from gross income (line 7) to get your tentative profit or loss (line 29). After subtracting home office expenses if applicable (line 30), you arrive at your net profit or loss (line 31). A profit flows to Form 1040, line 12, and Schedule SE, line 2, for self-employment tax calculation. A loss may be fully deductible, or it may be limited depending on your at-risk investment (line 32).

Common Mistakes and How to Avoid Them

Mixing Personal and Business Expenses

The most frequent error is deducting personal expenses as business costs—claiming personal vehicle miles, family meals, or home expenses unrelated to business use. Only the business portion of mixed-use items is deductible. Keep meticulous records and maintain separate bank accounts for business to avoid this trap.

Missing Documentation

Many taxpayers claim legitimate expenses but cannot prove them when the IRS asks. Save all receipts, invoices, bank statements, and mileage logs. For vehicle expenses, log each business trip's date, destination, purpose, and miles. For meals and entertainment (generally 50% deductible), note who you met and what business you discussed. Documentation requirements are particularly strict for listed property like vehicles and computers.

Forgetting Estimated Tax Payments

Unlike employees who have taxes withheld from paychecks, self-employed individuals must make quarterly estimated tax payments covering both income tax and self-employment tax. Failure to do so results in penalties even if you pay in full when filing your return. For 2013, you should have made estimated payments by April 15, June 17, September 16, and January 15, 2014.

Incorrectly Classifying Workers

If you pay others to help in your business, classification matters enormously. Employees require payroll tax withholding, W-2 forms, and potential benefits. Independent contractors receive 1099-MISC forms and handle their own taxes. Misclassifying employees as contractors triggers significant penalties. The IRS examines behavioral control, financial control, and the relationship's nature to determine proper classification.

Not Filing Information Returns

Failing to file required Forms 1099-MISC for payments of $600 or more to independent contractors and service providers results in penalties of $50 to $270 per form depending on how late you file. This requirement applies even if your business showed a loss. Line I specifically asks whether you complied, and checking ""No"" essentially invites IRS scrutiny.

Capitalizing vs. Expensing Inventory

If you sell products, you must track inventory and cannot deduct purchases until you sell the items. Many new business owners mistakenly deduct their entire inventory purchase in the year bought. Instead, complete Part III to calculate cost of goods sold based on what actually left your shelves.

What Happens After You File

Once you submit your Form 1040 with Schedule C attached, the IRS processes your return, which typically takes 4 to 6 weeks for paper returns or about 3 weeks for e-filed returns. The agency's computers automatically check for mathematical errors, missing forms, and discrepancies with information returns (like whether reported income matches Forms 1099 issued to you).

If you're due a refund, the IRS sends it after completing initial processing. If you owe additional tax, you'll receive a bill with payment instructions. Many returns are accepted without question and you'll hear nothing further beyond refund delivery or payment acknowledgment.

However, Schedule C filers face higher audit rates than wage earners, particularly for certain industries or expense patterns. The IRS may examine your return through a correspondence audit (sending letters requesting documentation of specific items) or, less commonly, an in-person examination. Common audit triggers include claiming a loss multiple years consecutively (suggesting hobby rather than business), unusually high expenses relative to income, round-number estimates throughout the form, and claiming 100% business use of vehicles or equipment.

If selected for audit, you'll receive a notice specifying which items the IRS questions and what documentation you must provide. Respond within the timeframe stated (typically 30 days) with copies of receipts, logs, bank statements, and other proof of income and expenses. The audit may result in acceptance of your return as filed, assessment of additional tax if the IRS disallows some deductions, or a refund if documentation supports additional deductions you didn't claim.

Your Schedule C profit also affects future obligations. Self-employment income triggers quarterly estimated tax requirements for 2014 and beyond. If this was your first year with substantial self-employment income, expect to make quarterly payments going forward to avoid underpayment penalties.

FAQs

Can I use Schedule C-EZ instead of the regular Schedule C?

You may qualify for the simplified Schedule C-EZ if your business expenses were $5,000 or less, you used the cash accounting method, had no inventory, didn't claim depreciation or Section 179 deductions, had no employees, and aren't claiming home office expenses. If you meet all these requirements, C-EZ offers a streamlined one-page alternative. However, most sole proprietors exceed the $5,000 expense threshold and must use the full Schedule C.

What's the difference between an employee and being self-employed?

Employees receive W-2 forms, have taxes withheld from paychecks, and their employers pay half of their Social Security and Medicare taxes. Self-employed individuals receive 1099-MISC forms (or no tax form at all), handle their own quarterly tax payments, and pay both the employee and employer portions of Social Security and Medicare—totaling 15.3% on net self-employment income. However, you can deduct half of your self-employment tax on Form 1040, line 27, and you have access to deductions and retirement plan contributions unavailable to employees.

Do I need an Employer Identification Number (EIN) for Schedule C?

Not necessarily. If you operate as a sole proprietor with no employees and don't maintain a qualified retirement plan, you can use your Social Security number instead. However, you need an EIN if you have employees, file employment tax returns, maintain certain pension plans, or file excise tax returns. Many sole proprietors obtain an EIN anyway to avoid giving their SSN to clients and vendors. You can apply for an EIN free online at IRS.gov using Form SS-4.

Can my spouse and I file one Schedule C for our jointly-run business?

Generally, if you and your spouse co-own and operate an unincorporated business, you're considered a partnership and must file Form 1065. However, if you both materially participate in the business and file a joint tax return, you can elect to be treated as a ""qualified joint venture."" Each spouse files a separate Schedule C reporting their share of income and expenses based on ownership interest. This election gives each spouse credit for Social Security earnings while avoiding the complexity of partnership returns. This option only works if you're the sole two owners and both actively participate.

What happens if my business shows a loss?

Business losses from Schedule C generally reduce your other taxable income (like wages from a job or investment income). However, the loss may be limited if you didn't materially participate in the business (making it passive), or if you have amounts invested in the business for which you're not ""at risk"" (meaning you're not personally liable for those amounts). Line 32 asks you to indicate whether all your investment is at risk. If not, you must file Form 6198 to calculate your allowable loss. Also be aware that showing losses year after year may cause the IRS to reclassify your activity as a hobby rather than a business, eliminating your ability to deduct the losses.

How long should I keep records after filing Schedule C?

The IRS generally has three years from your filing date to audit your return, so keep all supporting documentation at least that long. However, if you substantially underreport income (by 25% or more), the IRS has six years to audit. If you don't file a return or file a fraudulent one, there's no time limit. The IRS recommends keeping records for at least three years for most situations, but seven years provides a safer margin. For records related to property (showing what you paid for assets you're depreciating), keep them for at least three years after you dispose of the property.

Can I deduct meals and entertainment for my business?

Yes, but with significant limitations. Business meals and entertainment are generally 50% deductible, meaning if you take a client to lunch and spend $100, you can deduct $50. You must have a legitimate business purpose (discussing business before, during, or after the meal), and the expense must be ordinary and necessary for your business. Keep detailed records showing the date, place, amount, business purpose, and who attended. Pure entertainment expenses (like tickets to shows or sporting events) follow the same rules. Travel meals while away from home on business also qualify for the 50% deduction.

Sources: All information derived from official IRS publications including 2013 Schedule C Form 1040 and 2013 Instructions for Schedule C.

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