Schedule C (Form 1040): Profit or Loss From Business (2014) – A Complete Guide for Small Business Owners and Self-Employed Individuals
What Schedule C (Form 1040) Is For
Schedule C is the tax form used by sole proprietors, independent contractors, and self-employed individuals to report income and expenses from a business they operated during the tax year. Think of it as your business's financial report card that attaches to your personal Form 1040 tax return. Whether you're a freelance graphic designer, an independent consultant, a small retail shop owner, or someone who drives for a ride-sharing service, Schedule C is how you tell the IRS about your business activities.
The form serves several important purposes beyond simply reporting your profit or loss. It helps determine how much self-employment tax you owe (which covers your Social Security and Medicare contributions), calculates your taxable business income, and documents the legitimate business expenses you can deduct to reduce your tax bill. An activity qualifies as a business—rather than a hobby—when your primary purpose is earning income or profit and you're involved with continuity and regularity. Sporadic activities or hobbies don't qualify, and their income would be reported differently on your tax return.
Schedule C can also be used by statutory employees (certain types of workers who receive a W-2 with the ""Statutory employee"" box checked), qualified joint ventures between spouses, and to report certain income shown on Form 1099-MISC. If your business expenses were $5,000 or less and you meet other simplified requirements, you might qualify to use the shorter Schedule C-EZ instead.
When You'd Use Schedule C (Form 1040)
You file Schedule C with your annual Form 1040 tax return, typically due on April 15th following the end of the tax year (or the next business day if April 15th falls on a weekend or holiday). For the 2014 tax year, this would have been April 15, 2015. If you need more time, you can request an extension, but remember that an extension to file is not an extension to pay any taxes owed—you still need to estimate and pay what you owe by the original deadline to avoid interest and penalties.
If you started or acquired a business during 2014, you would check the box on Line H and file Schedule C for that year even if you only operated for part of the year. Similarly, if you're reopening a business after temporarily closing it, you'd file Schedule C and indicate the restart.
Sometimes you need to file an amended return to correct errors or claim additional deductions you forgot. To amend a Schedule C, you file Form 1040-X (Amended U.S. Individual Income Tax Return) with the corrected Schedule C attached. The clock for amendments is important: generally, you must file Form 1040-X within three years after the date you filed your original return or within two years after the date you paid the tax, whichever is later. For example, if you filed your 2014 return on April 15, 2015, you'd typically have until April 15, 2018, to file an amended return claiming a refund.
Late filing penalties can be substantial if you miss the deadline without filing an extension. The failure-to-file penalty is typically 5% of the unpaid taxes for each month or part of a month that your return is late, up to a maximum of 25%. If you owe self-employment tax from your Schedule C income, late filing can quickly become expensive, making it important to file on time even if you can't pay the full amount immediately.
Key Rules or Details for 2014
Several fundamental rules govern how Schedule C works. First, you must use a consistent accounting method—either cash or accrual. Most small businesses use the cash method, meaning you report income when you actually receive it and deduct expenses when you actually pay them. The accrual method reports income when earned and expenses when incurred, regardless of when money changes hands. Special rules apply if you maintain inventory; generally, you must use the accrual method for purchases and sales of inventory items unless you qualify as a small business taxpayer.
Material participation is another critical concept. You must indicate on Line G whether you ""materially participated"" in your business activity. Material participation generally means you worked more than 500 hours during the year in the business, or your participation was substantially all the participation in the activity, or you participated more than 100 hours and at least as much as anyone else. Why does this matter? If you didn't materially participate, your business may be considered a passive activity, and passive activity losses can only offset passive income—they can't reduce your other income like wages or interest. This prevents taxpayers from using business losses to shelter unrelated income when they're not genuinely active in the business.
The self-employment tax obligation is perhaps the most important rule Schedule C filers need to understand. Unlike employees who have Social Security and Medicare taxes automatically withheld from paychecks, self-employed individuals must calculate and pay these taxes themselves. If your net profit from Schedule C is $400 or more, you must file Schedule SE (Self-Employment Tax) and pay self-employment tax at a rate of 15.3% on your net earnings (though you can deduct half of this amount as an adjustment to income). For 2014, the maximum income subject to the Social Security portion was $117,000.
Business expenses must be both ""ordinary and necessary"" to be deductible. Ordinary means common and accepted in your trade or business, while necessary means helpful and appropriate. The expense doesn't have to be indispensable, but it should have a clear business purpose. Personal expenses are never deductible, and mixed-use expenses (like a cell phone used for both business and personal calls) must be allocated proportionally.
Step-by-Step (High Level)
The form begins with identifying information: your name, Social Security number, business name (if you have one), and the principal business code that best describes your activity. You'll also indicate whether you materially participated in the business and whether you're required to file certain information returns like Forms 1099.
Part I deals with income. Line 1 is your gross receipts or sales—the total money your business brought in before subtracting expenses. You subtract returns and allowances on Line 2, then calculate your cost of goods sold on Line 4 (if you sell products rather than services). Other business income goes on Line 6. Your gross income is the result after these calculations.
Part II is where you deduct your business expenses. The form lists common expense categories with specific lines: advertising, car and truck expenses, commissions and fees, contract labor, depreciation, employee benefit programs, insurance, interest, legal and professional services, office expenses, rent, repairs and maintenance, supplies, taxes and licenses, travel and meals, utilities, and wages. Each has its own line, and there's also a Line 27 for miscellaneous expenses and a Part V section for listing those other expenses.
Some expenses require special attention. Vehicle expenses can be calculated using either actual costs or the standard mileage rate (56 cents per mile for 2014). Home office expenses have specific requirements and may be calculated using either the simplified method ($5 per square foot, maximum 300 square feet) or the actual expense method using Form 8829. Depreciation on business assets requires Form 4562 if you placed property in service during 2014 or are claiming a Section 179 deduction to expense equipment purchases.
Part III addresses cost of goods sold for businesses that maintain inventory, requiring you to track beginning inventory, purchases, labor costs, materials, and ending inventory using either the cash or accrual method.
Part IV collects vehicle information if you're claiming car or truck expenses, including details about when you placed the vehicle in service, mileage breakdown, and whether you have evidence to support your deductions.
Finally, you transfer your net profit or loss from Line 31 to Form 1040, Line 12. If you have a profit, you'll also report it on Schedule SE to calculate self-employment tax. Your net profit becomes part of your adjusted gross income, affecting your overall tax liability.
Common Mistakes and How to Avoid Them
One of the most frequent errors is mixing personal and business expenses. The IRS is particularly watchful for this issue. Keep separate bank accounts and credit cards for business use, and never deduct personal expenses like family meals, commuting from home to your regular place of business, or clothing suitable for everyday wear. Even if you bought a suit for business meetings, it's not deductible because you could wear it for personal occasions.
Many filers incorrectly calculate vehicle expenses, particularly when switching between the standard mileage rate and actual expenses. If you use the standard mileage rate in the first year you use your car for business, you can switch to actual expenses in later years. However, if you use actual expenses first (including depreciation), you're locked into that method for that vehicle. Keep a detailed mileage log showing dates, destinations, business purposes, and miles driven—this is the documentation the IRS expects if they question your deduction.
Home office deductions trigger mistakes because the rules are strict. Your home office space must be used regularly and exclusively for business. ""Exclusively"" means you can't use that space for anything else—not watching TV, not letting kids do homework there. It must also be either your principal place of business or a place where you meet clients or customers in the normal course of business. Many taxpayers incorrectly claim a home office deduction when they occasionally work at their kitchen table or in a bedroom that also functions as a guest room.
Failing to report all income is a serious error that the IRS can easily catch through document matching. When clients or customers pay you $600 or more, they typically issue a Form 1099-MISC to both you and the IRS. If you don't report that income on Schedule C, the IRS computers will flag the discrepancy and send you a notice. Report all business income, even if you didn't receive a 1099 for it.
Incorrect accounting method selection causes problems, especially for businesses with inventory. If you manufacture products or buy goods for resale, you generally must use the accrual method for inventory and can't simply deduct purchases as supplies. This means tracking your inventory at the beginning and end of the year in Part III.
Overlooking the home office simplified method (new in 2014) causes some taxpayers to do more work than necessary. If your home office is 300 square feet or less, you can multiply the square footage by $5 and take that as your deduction—no need to track all your home expenses and calculate the business-use percentage. This simplified approach saves time and reduces audit risk.
Finally, many business owners forget to make quarterly estimated tax payments throughout the year. Since you don't have an employer withholding taxes, you're responsible for paying both income tax and self-employment tax on your Schedule C profit. If you expect to owe $1,000 or more in taxes, you should make quarterly estimated payments to avoid underpayment penalties.
What Happens After You File
Once you submit your tax return with Schedule C attached, the IRS processes it through their systems. If you file electronically, you'll typically receive acknowledgment of receipt within 24-48 hours. Paper returns take longer to process—often six to eight weeks before the IRS enters them into their system.
The IRS computers automatically check for mathematical errors, missing forms, and inconsistencies with information documents (like Forms 1099 and W-2). If they find a simple math error, they'll typically correct it and adjust your refund or balance due accordingly, sending you a notice explaining the change. You don't need to file an amended return for errors the IRS corrects automatically.
If you're due a refund, the IRS typically issues it within 21 days for electronically filed returns with direct deposit, though paper returns take longer. The IRS will apply your refund to any outstanding tax debts you owe before sending you the remainder. You can check your refund status using the ""Where's My Refund?"" tool on IRS.gov.
When your Schedule C shows a profit, that income flows through to your Form 1040 and increases your adjusted gross income. This affects not only your income tax but also your eligibility for various tax credits and deductions that phase out at higher income levels. The profit also generates self-employment tax liability reported on Schedule SE.
Some Schedule C returns are selected for examination (audit). The IRS doesn't audit returns randomly; they use computer models to identify returns with characteristics suggesting potential errors or underreporting. Certain items raise audit risk, including large vehicle expenses, substantial home office deductions, consistent losses year after year, or income and expenses that don't match industry norms for your type of business. Having a Schedule C doesn't mean you'll be audited—the vast majority of returns aren't—but maintaining good records is essential in case you're selected.
If selected for examination, you'll receive a notice specifying what the IRS wants to review. This might be a correspondence audit (conducted by mail) or an office/field audit (conducted in person). Having organized records of your income and expenses, mileage logs, receipts, cancelled checks, and bank statements is crucial for substantiating your Schedule C entries.
The IRS has three years from when you file (or the due date, if later) to assess additional tax for most situations. This statute of limitations extends to six years if you underreported your income by more than 25%, and there's no time limit if you never filed a return or filed a fraudulent return.
FAQs
How much income do I need to file Schedule C?
There's no minimum income requirement for filing Schedule C—if you operated a business, you report your income and expenses regardless of the amount. However, the broader question is whether you need to file a tax return at all. For 2014, if your net earnings from self-employment were $400 or more, you must file a return to pay self-employment tax, even if your income is below the normal filing threshold. If you had a net loss, you'd still want to file to claim that loss against other income.
Can married couples file one Schedule C for a jointly owned business?
Generally, if spouses jointly own and operate a business, they must treat it as a partnership and file Form 1065 instead of Schedule C. However, there are two exceptions: if you live in a community property state and treat the business as a sole proprietorship, or if you elect ""qualified joint venture"" status. With qualified joint venture election, each spouse files a separate Schedule C reporting their share of income and expenses, which allows each person to receive Social Security credits for their business earnings while avoiding the complexity of partnership returns.
What's the difference between Schedule C and Schedule C-EZ?
Schedule C-EZ is a simplified version you can use if you meet all these conditions: your business expenses were $5,000 or less, you use the cash method of accounting, you didn't have inventory during the year, you didn't have a net loss, you had only one business as a sole proprietor, you had no employees, you're not claiming depreciation or the Section 179 deduction, you have no prior-year passive activity losses, and you're not claiming home office expenses. Most business owners don't qualify for C-EZ, but if you do, it's a single-page form that's much simpler to complete.
Do I need an Employer Identification Number (EIN) to file Schedule C?
Not necessarily. You only need an EIN if you have employees, have a qualified retirement plan (like a SEP or SIMPLE), or are required to file certain employment, excise, alcohol, tobacco, or firearms tax returns. Many sole proprietors without employees use their Social Security number instead. However, getting an EIN is free and can help protect your Social Security number from excessive exposure. If you do have an EIN, enter it on Line D; otherwise, leave that line blank.
Can I deduct my health insurance premiums on Schedule C?
No, self-employed health insurance premiums don't go on Schedule C. Instead, if you qualify, you deduct them on Form 1040, Line 29, as an ""above-the-line"" deduction that reduces your adjusted gross income. You can qualify if you show a net profit on Schedule C (or would have except for the insurance premium deduction), you weren't eligible to participate in an employer-sponsored health plan through your own or your spouse's employer, and the insurance plan is in your name or your business's name. This deduction is limited to your net profit from self-employment.
What if I have both a regular job and a side business?
You report your W-2 wages from your regular job on Form 1040, Line 7, and your business income and expenses from your side business on Schedule C. The Schedule C profit or loss goes on Form 1040, Line 12. If your net profit from the side business is $400 or more, you'll owe self-employment tax on it (calculated on Schedule SE), even though you're already paying Social Security and Medicare taxes through your regular job. You may need to make quarterly estimated tax payments to cover the additional tax liability from your business, or you can ask your employer to increase your withholding using a new Form W-4.
What records do I need to keep and for how long?
Keep all records supporting income and expenses on your Schedule C for at least three years from the date you filed your return (or the due date, if later), since that's generally how long the IRS has to audit you. However, keep records for six years if you underreported income by more than 25%, and keep records indefinitely for property (including depreciation schedules) until the period expires for the year you dispose of the property. Good records include bank statements, receipts, cancelled checks, invoices, mileage logs, and any Forms 1099 you received. Consider keeping records digitally by scanning receipts—many accounting software programs and apps can help organize business records and make Schedule C preparation much easier.
Source: All information is derived from official IRS.gov publications, including the 2014 Instructions for Schedule C (Form 1040), 2014 Form 1040 Schedule C, Instructions for Form 1040-X, Instructions for Schedule SE, Instructions for Form 8829, and related IRS.gov guidance on small business taxation.
