Schedule C is used by many small businesses to report annual revenues and expenses. It is one of many schedules that may be included with your Individual Income tax return (Form 1040). In other words, you can own and operate a business and do not have to file a totally separate tax return for the business.
If a business is just starting out, the owner should consider using Schedule C. It allows for the deduction of normal business expenses to offset revenues. If you have a home office it’s easy to allocate the expenses associated with it to Schedule C. If you use your vehicle for both personal and business, it is easy to split the expenses between the two. The same goes for cell phones. There are numerous benefits to using Schedule C, but not everything is rosy.
The IRS has limited patience with Schedule C business losses that occur year after year. You must make a profit at least three of every five years or you may be in trouble. If all you do is lose money the IRS will argue that you are not running a legitimate business; you are just messing around with a hobby. If that becomes the case, you do not get to deduct expenses but do have to report the income. This restriction is very unfair to new businesses that are trying to establish themselves but just haven’t quite turned the corner. The IRS knows this rule would be unfair if it was set in stone, so they have other tests to determine if you do in fact have a legitimate business. Some factors they consider are the amount of time you spend on the activity, the likelihood that you will make a profit in the not too distant future and the segregation between your business and personal affairs (like having separate bank and credit card accounts for the business).
A majorly negative aspect of using Schedule C is Self-Employment Tax. The IRS charges this tax to fund Social Security and Medicare, and the rate depends on the amount of Net Income the business generates during the year. See our blog on Self-Employment Tax for more details on this costly tax.
Another unfortunate aspect is that Schedule C is very restrictive with regard to ownership because only you and your spouse can be owners of the company. If you have a non-spouse business partner, you will not be able to use Schedule C and must report your taxes in an alternate manner.
Overall Schedule C is a really convenient method to report your business activity, especially when things are just getting started. As your business grows it will probably outgrow Schedule C at some point, but use it while you can.
Joe Wright CPA PLLC provides the information in this blog as a general guide. Tax laws are extremely complex, and every taxpayer is unique. Some or all of this information may or may not apply to you. We provide simplified situations to clarify some of the major aspects and highlights of the topic at hand. Some of the language used is casual and may be misconstrued. Please make an appointment with us soon to discuss your particular circumstances.