Schedule C (Form 1040): Profit or Loss From Business (2017) – A Taxpayer's Guide
Schedule C (Form 1040) is the IRS form that sole proprietors and certain other taxpayers use to report income or loss from a business they operated or a profession they practiced. Think of it as your business's financial report card that gets attached to your personal tax return. Unlike corporations or partnerships that file separate business tax returns, sole proprietors use Schedule C to combine their business financials with their individual tax filing.
The form serves several specific purposes beyond basic sole proprietorship reporting. It's also used by statutory employees (such as full-time life insurance agents, certain delivery drivers, and traveling salespeople) to report wages and business expenses. Married couples can use it to report income from qualified joint ventures, allowing both spouses to receive Social Security credits without the complexity of filing a partnership return. Single-member LLCs that haven't elected corporate tax treatment also report their business activity on Schedule C.
An important distinction: your activity must be a genuine business, not a hobby. The IRS considers something a business when your primary purpose is earning income or profit and you pursue it with continuity and regularity. Sporadic activities or hobbies—even if they occasionally generate income—don't qualify for Schedule C reporting and should instead be reported elsewhere on your tax return.
What Schedule C (Form 1040) Is For
Schedule C (Form 1040) is the IRS form that sole proprietors and certain other taxpayers use to report income or loss from a business they operated or a profession they practiced. Think of it as your business's financial report card that gets attached to your personal tax return. Unlike corporations or partnerships that file separate business tax returns, sole proprietors use Schedule C to combine their business financials with their individual tax filing.
The form serves several specific purposes beyond basic sole proprietorship reporting. It's also used by statutory employees (such as full-time life insurance agents, certain delivery drivers, and traveling salespeople) to report wages and business expenses. Married couples can use it to report income from qualified joint ventures, allowing both spouses to receive Social Security credits without the complexity of filing a partnership return. Single-member LLCs that haven't elected corporate tax treatment also report their business activity on Schedule C.
An important distinction: your activity must be a genuine business, not a hobby. The IRS considers something a business when your primary purpose is earning income or profit and you pursue it with continuity and regularity. Sporadic activities or hobbies—even if they occasionally generate income—don't qualify for Schedule C reporting and should instead be reported elsewhere on your tax return.
When You’d Use Schedule C (Form 1040)
Schedule C must be filed by the standard April tax deadline (typically April 15, unless it falls on a weekend or holiday). If you're filing late or need to correct a previously filed Schedule C, you'll use Form 1040-X (Amended U.S. Individual Income Tax Return) and attach a corrected Schedule C.
If you discover an error after filing your original return, filing an amended return allows you to correct mistakes, report additional income you initially overlooked, or claim deductions you forgot. The good news: if you file an amended return that increases your tax liability before the original due date has passed, you can avoid penalties and interest by paying the additional tax promptly. However, if you're amending after the deadline and owe more tax, the IRS will calculate interest on the unpaid amount from the original due date.
Failure to file Schedule C on time when you have a tax liability triggers two types of penalties. The failure-to-file penalty is typically 5% of the unpaid tax for each month (or part of a month) the return is late, up to a maximum of 25%. If your return is more than 60 days late, there's a minimum penalty—the lesser of $510 or 100% of the unpaid tax (for 2017 tax year returns). Additionally, a failure-to-pay penalty of 0.5% per month applies to any unpaid tax amount. These penalties can be reduced or eliminated if you can show reasonable cause for the delay.
Key Rules or Details for Tax Year 2017
Separate Schedule for Each Business: If you operate multiple businesses, you cannot combine them on a single Schedule C. Each distinct business activity requires its own form, which helps the IRS track income sources and ensures proper reporting.
Accounting Method Matters: You must choose an accounting method—cash, accrual, or another IRS-approved method—and use it consistently. Most small businesses use the cash method, recognizing income when received and expenses when paid. Under the accrual method, you report income when earned and expenses when incurred, regardless of when cash changes hands. Special rules apply to businesses with inventory, which generally must use an accrual method for purchases and sales of inventory items.
Material Participation Test: Line G of Schedule C asks whether you "materially participated" in the business. This isn't just a formality—it determines whether your business is considered active or passive for tax purposes. You materially participate if you meet one of seven tests, the most common being working more than 500 hours in the business during the year. If you check "No" and have a loss, passive activity loss limitations may restrict how much you can deduct.
Self-Employment Tax Connection: Nearly all Schedule C net profit is subject to self-employment tax (Social Security and Medicare taxes). If your net earnings from self-employment are $400 or more, you must file Schedule SE to calculate this tax. The self-employment tax rate for 2017 was 15.3% on net earnings (combining both the employer and employee portions), though you can deduct half of this amount as an adjustment to income on Form 1040.
Information Return Requirements: If you paid $600 or more during the year to any individual or unincorporated business for services, rent, or other business expenses, you generally must file Form 1099-MISC. Line I of Schedule C requires you to confirm whether you made such payments and filed the required forms. Failure to file information returns can result in separate penalties.
Step-by-Step (High Level)
Step 1: Identification Section
Step 1: Identification Section – Start by entering your name, Social Security number, and basic business information. Describe your principal business activity specifically (for example, "retail sale of sporting goods" rather than just "retail"), select the appropriate six-digit business activity code from the IRS list, and provide your business name and employer identification number (EIN) if applicable. Indicate your accounting method and whether you materially participated in the business.
Step 2: Calculate Gross Income (Part I)
Step 2: Calculate Gross Income (Part I) – Report your gross receipts or sales on line 1, then subtract returns and allowances on line 2 to get net sales on line 3. If you maintain inventory, complete Part III (Cost of Goods Sold) and enter the result on line 4. Subtract cost of goods sold from net sales to determine gross profit on line 5. Add any other business income—such as recovered bad debts, interest on accounts receivable, or miscellaneous income—on line 6. The total on line 7 is your gross income from the business.
Step 3: List Your Expenses (Part II)
Step 3: List Your Expenses (Part II) – The form provides specific lines for common business expenses, including advertising, car and truck expenses, insurance, interest, legal and professional services, office expenses, rent, repairs, supplies, taxes, travel, meals and entertainment, utilities, and wages. Each expense category has specific rules about what qualifies and how much you can deduct. Total all expenses on line 28 to determine your expenses before home office deductions.
Step 4: Apply Home Office Deduction
Step 4: Apply Home Office Deduction – If you qualify for the business use of your home deduction (meeting strict exclusive and regular use tests), you can claim it on line 30. You can either use the simplified method (multiply your home office square footage by $5, up to 300 square feet) or complete Form 8829 to calculate actual expenses. Only claim this deduction if your home office space is used exclusively and regularly for business.
Step 5: Determine Net Profit or Loss
Step 5: Determine Net Profit or Loss – Subtract total expenses (line 28) and home office expenses (line 30) from gross income (line 7) to arrive at your net profit or loss on line 31. If you show a profit, this amount flows to Form 1040 and Schedule SE for self-employment tax calculation. If you show a loss, you must indicate on line 32 whether all your investment in the business is at risk or whether some is protected from loss—this determination affects whether you can deduct the full loss or must complete Form 6198 to calculate a limited loss.
Step 6: Complete Supporting Schedules
Step 6: Complete Supporting Schedules – Part III calculates cost of goods sold if you have inventory. Part IV collects information about your vehicle if you claimed car expenses and aren't required to file Form 4562. Part V lists "other expenses" not fitting the predefined categories in Part II.
Common Mistakes and How to Avoid Them
Treating Hobbies as Businesses
Treating Hobbies as Businesses: One of the most frequent errors is reporting hobby income on Schedule C. The IRS distinguishes between hobbies and businesses based on profit motive, regularity, and business-like operation. If your activity lacks a legitimate profit motive and you engage in it sporadically, it's a hobby. Hobby income gets reported on Form 1040, and hobby expenses cannot exceed hobby income (and have different deduction limitations). Keep records showing your business intent—business plans, marketing efforts, separate business bank accounts, and efforts to improve profitability all demonstrate business purpose.
Mixing Personal and Business Expenses
Mixing Personal and Business Expenses: Attempting to deduct personal expenses as business costs is another common pitfall. The base rate for your first home phone line is never deductible, even if you use that phone for business calls. Personal portions of mixed-use expenses (like vehicle costs or home expenses) must be carefully calculated and separated. Maintain detailed records showing the business percentage of any shared expenses, and never round up your business use beyond what you can document.
Forgetting Information Returns
Forgetting Information Returns: Many business owners overlook their obligation to file Forms 1099-MISC when they pay contractors, professionals, or service providers $600 or more during the year. The IRS matches these information returns against recipient tax filings, and failure to file can result in penalties starting at $50 per form (with higher amounts for intentional disregard). Keep accurate records of all payments to unincorporated businesses and individuals throughout the year, collect Form W-9 from your vendors at the start of the relationship, and file required 1099s by the January 31 deadline following the tax year.
Combining Multiple Businesses
Combining Multiple Businesses: Operating several distinct business activities doesn't allow you to net the profit from one against the loss of another on a single Schedule C. Each separate business requires its own Schedule C, which allows proper tracking and prevents confusion. A separate business is typically one with a different principal activity, customer base, or business model. For example, if you run both a graphic design service and rent out residential property, these require separate schedules (Schedule C for design, Schedule E for rental property).
Mishandling Statutory Employee Income
Mishandling Statutory Employee Income: If you received a Form W-2 with the "Statutory employee" box checked in box 13, you must file a separate Schedule C for those earnings and cannot combine them with other self-employment income on the same form. Statutory employee wages have already had Social Security and Medicare tax withheld, so mixing them with regular self-employment income leads to incorrect self-employment tax calculations. Check the box on line 1 of Schedule C to indicate statutory employee income, and file Schedule SE only for your regular self-employment earnings.
Inadequate Recordkeeping
Inadequate Recordkeeping: The IRS requires written evidence to support your deductions. Without receipts, logs, invoices, canceled checks, or other documentation, deductions may be disallowed during an audit. This is especially critical for travel, meals and entertainment, vehicle expenses, and home office deductions, which face heightened IRS scrutiny. Maintain contemporaneous records—meaning created at or near the time of the expense—rather than trying to reconstruct documentation later.
What Happens After You File
Once you complete and file Schedule C with your Form 1040, several things occur automatically through the tax system. The net profit or loss from line 31 of Schedule C transfers directly to Form 1040, where it becomes part of your total income. This means your business earnings (or losses) integrate with your other income sources—wages, interest, dividends, and other items—to determine your overall tax liability or refund.
If your Schedule C shows net profit of $400 or more, you must also complete Schedule SE (Self-Employment Tax) to calculate Social Security and Medicare taxes on your business earnings. Self-employment tax for 2017 was 15.3% (12.4% for Social Security on earnings up to $127,200, and 2.9% for Medicare on all earnings). The good news is you can deduct one-half of your self-employment tax as an adjustment to income on Form 1040, line 27, which reduces your adjusted gross income without needing to itemize deductions.
Your Schedule C results also affect other tax benefits and obligations. Net profit from your business counts as earned income, which may qualify you for the Earned Income Credit if you meet income limits and other requirements. Conversely, if you have a loss and didn't materially participate in the business, passive activity loss limitations might restrict how much loss you can deduct in the current year—you'll need Form 8582 to calculate your allowable loss, with any excess carried forward to future years.
The IRS processes your return and may select it for further review or audit. Schedule C filers face slightly higher audit rates than wage earners because of the self-reported nature of business income and the complexity of business expense deductions. Most audits occur within three years of filing, though the IRS has six years if they suspect you underreported income by 25% or more. If selected for examination, you'll receive a letter explaining what information the IRS needs to verify your reported income and deductions.
Your Schedule C information also establishes your business income for other purposes. It determines your quarterly estimated tax obligations for the following year—if you expect to owe $1,000 or more in tax after withholding and credits, you must make quarterly estimated payments using Form 1040-ES. Additionally, your reported business earnings factor into your Social Security earnings record, affecting your eventual retirement benefits, disability coverage, and Medicare eligibility.
FAQs
Do I need an Employer Identification Number (EIN) to file Schedule C?
Most sole proprietors without employees can use their Social Security number and don't need an EIN. However, you must obtain an EIN if you have a qualified retirement plan (like a solo 401(k) or SEP-IRA), hire employees, are required to file employment or excise tax returns, or are a payer of gambling winnings. Single-member LLCs need an EIN for these same purposes. You can apply for an EIN online through the IRS website, and it's issued immediately at no cost.
Can married couples file a single Schedule C for a business they own together?
Generally, spouses who jointly own and operate an unincorporated business are considered partners and must file Form 1065 (partnership return). However, there's an important exception: qualifying joint ventures. If both spouses materially participate in the business, are the only owners, and file a joint tax return, they can elect to be treated as a qualified joint venture. This allows each spouse to file a separate Schedule C reporting their share of income and expenses, which provides both spouses with Social Security credits without the complexity of partnership filing. This election is especially valuable for building each spouse's Social Security earnings history for retirement benefits.
What's the difference between Schedule C and Schedule C-EZ?
Schedule C-EZ is a simplified one-page version of Schedule C available to small businesses meeting specific requirements. You can use Schedule C-EZ only if your business expenses are $5,000 or less, you use the cash method of accounting, you had no inventory, you had no net loss, you had no employees, you're not claiming depreciation or Section 179 deductions, and you have no prior passive activity losses. Many businesses don't qualify because even modest depreciation or slightly higher expenses require the full Schedule C form.
How do I prove material participation if the IRS questions my business activity?
Material participation isn't just a checkbox—it's a factual determination based on seven specific tests. The most straightforward is participating more than 500 hours during the year in your business. Other tests include doing substantially all the work in the business, working more than 100 hours and at least as much as anyone else, or materially participating in the activity for any five of the prior ten years. Maintain contemporaneous records of your time spent on business activities—appointment calendars, logs, time sheets, or other records created at the time showing dates and hours worked. These records prove invaluable if the IRS questions whether your participation was truly "material" for passive activity loss rules.
What if my Schedule C shows a loss every year—will the IRS consider it a hobby?
Sustained losses can trigger hobby loss concerns, especially if you don't show a profit in at least three of five consecutive years (two of seven years for horse-related activities). However, this "presumption rule" isn't absolute. You can rebut the hobby presumption by demonstrating business-like operations: maintaining complete and accurate books, developing a business plan, engaging in marketing and advertising, modifying operations to improve profitability, having expertise in the field, devoting substantial time to the activity, and showing an expectation of asset appreciation. The IRS considers the totality of circumstances, not just whether you turned a profit. Document your profit-seeking behavior thoroughly.
Must I report all business income even if I didn't receive a Form 1099-MISC?
Yes—absolutely all business income must be reported, regardless of whether you received information returns. The IRS knows that not all income gets reported on 1099s (customers aren't required to issue them for payments under $600 or for many types of transactions). Gross receipts on line 1 of Schedule C should include all money received for goods sold or services performed in your business, whether paid by cash, check, credit card, digital payment, or barter. Attempting to hide unreported income is considered tax evasion and can result in substantial penalties, interest, and potentially criminal prosecution. If the total shown on Forms 1099-MISC you received exceeds what you're reporting on line 1, attach a statement explaining the difference (for example, if a 1099 included reimbursed expenses or was issued in error).
Can I deduct my health insurance premiums as a business expense on Schedule C?
This is a common area of confusion. Health insurance premiums you pay for coverage for yourself, your spouse, and your dependents are not deductible on Schedule C itself. However, if you have a net profit reported on Schedule C and aren't eligible to participate in an employer-subsidized health plan (through your own employer if you have a job, or your spouse's employer), you can deduct health insurance premiums as an adjustment to income on Form 1040, line 29. This gives you the deduction without itemizing and without it being subject to the adjusted gross income floor that applies to medical expenses on Schedule A. You can deduct health insurance for employees on Schedule C, line 14, but premiums for yourself go on the separate line on Form 1040.
This guide summarizes information from official IRS sources for the 2017 tax year. Tax laws change regularly, so always consult current IRS publications or a qualified tax professional for guidance specific to your situation. For the most recent Schedule C instructions and forms, visit IRS.gov/ScheduleC.
