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1040 Schedule C: All You Need To Know As Self-Employed

All those who are self-employed, carrying on their business as a sole proprietor, an independent contractor, a member of a partnership, or working for themselves in any other way (like a Shopify business owner) may have come across Form 1040 Schedule C.

Well, of all the tax forms, Schedule C is one such form that you need to file as a self-employed individual, along with your Form 1040 to report income or loss from a business you operated.

As per IRS, you are self-employed if you:

  • Carry on a trade or business as a sole proprietor or an independent contractor.
  • Are a member of a partnership that carries on a trade or business.
  • Are you otherwise in business for yourself including a part-time business or a gig worker?

Thus, if you are a self-employed individual who has been struggling to understand what Form 1040 Schedule is and how to file one, then you have come to the right place.

In this article, we will walk you through Form 1040 Schedule C in detail, when you need to file 1040 Schedule C, and how to file 1040 Schedule C as a self-employed.

What is Form 1040 Schedule C?

Form 1040 Schedule C is an IRS form that self-employed individuals need to file with IRS to report income or loss from the business they operate or a profession they practice as sole proprietors.

Further, Form 1040 Schedule C also showcases the expenses that the self-employed taxpayer incurred to carry on the business or trade over a period of 12 months during the taxable year.

Further, individuals may also use Schedule C to report:

  • Wages and expenses they had earned and incurred working as independent contractors but were treated as employees for tax withholding purposes. Provided such independent contractors do the work themselves, have not invested largely in the tools and property they use to carry out their work, and worked for one employer on a continuing basis. These wages and expenses may be related to the gig work or freelance projects that the taxpayers may have undertaken to earn additional income apart from what they earn as full-time employees.
  • Income and deductions of certain qualified joint ventures. A taxpayer and his or her spouse can enter into a qualified joint venture instead of a partnership provided each of them materially participate in the business, are the sole owner of their business, and file a joint return for the tax year.
  • Certain amounts are showcased on a specific type of Form 1099, such as Form 1099-MISC, Form 1099-NEC, and Form 1099-K. The individuals must see instructions mentioned on their specific Form 1099 type to know what they should report on Schedule C.

Now, before filing Form 1040 Schedule C, taxpayers must ensure 2 things: (1) they are self-employed and (2) the activity that they engaged in must be a business activity.

To make things easier to understand, IRS defines who is a self-employed individual and what constitutes a business activity. The following section defines who is self-employed and the difference between a hobby and a business activity as defined by the IRS.

Alan Chen, CPA at Freecashflow.io, helping eCommerce businesses with their tax and accounting

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Who is a Self-Employed?

As per IRS, an individual is self-employed if he or she :

  • Carries on a trade or a business as a sole proprietor or as an independent contractor.
  • Is a member of a partnership that runs a trade or a business.
  • Is otherwise in a business for himself or herself including a part-time business or as a gig worker.

Further, self-employment can include work in addition to the regular full-time business activities that a taxpayer is engaged in. These activities may include part-time work or any work that is in addition to the regular job of the taxpayer. For instance, a taxpayer may work as a freelancer or a gig worker on any of the digital platforms that provide work opportunities in a wide variety of fields.

Hobby Income Vs Business Income: How To Know Whether an Activity is a Hobby or Business?

Another thing that a taxpayer must ensure before filing Form 1040 Schedule C is that the activity that he or she is engaged in must be a business activity.

To know whether an activity is categorized as business, all individuals filing taxes must know what constitutes a business activity as per IRS. There are different factors that they should consider while determining whether an activity is a business activity or a hobby.

One of the fundamental factors to qualify an activity as a business activity is that the primary purpose with which the taxpayer carries out that activity is for income or profit. Besides this, the self-employed must be involved in the activity continuously and regularly.

In addition to these factors, the following are a few of the other factors that a taxpayer must consider to determine whether an activity is a business activity or a hobby:

  • The taxpayers must maintain complete and accurate books and records indicating that the activity they are engaged in is for earning profits.
  • The time and effort that the taxpayers put into the activity showcase that they intend to make it profitable.
  • The taxpayers must necessarily depend on income from the activity for their livelihood.
  • If the taxpayers incur losses, they are due to circumstances beyond the taxpayers’ control or are normal for the startup phase of their business type.
  • The taxpayers can change methods of operation to improve profitability.
    Additionally, the taxpayers and their advisors have the requisite knowledge to carry out the activity successfully.
  • Taxpayers were successful in generating profits in similar activities in the past.
  • The activity that the taxpayers are engaged in makes a profit in some years and how much profit it makes.
  • The taxpayers can expect to make a profit in the future from the appreciation of the assets used in the activity.

Who Should File Form 1040 Schedule C?

The following are the individuals or entities who need to file Form 1040 Schedule C.

a. Sole Proprietors

Anyone who owns an unincorporated business by himself or herself is a sole proprietor. Thus, sole proprietors running a business or practicing a profession with regularity and with the sole purpose to earn a profit are required to file Form 1040 Schedule C.

b. Single Member LLC

A Limited Liability Company (LLC) is a hybrid form of business structure that has chosen features of both company and partnership forms of business.

It enjoys the advantages of pass-through taxation and flexibility in routine operations and management of a partnership together with a limited liability advantage available to owners in the case of a C corporation.

An LLC is formulated with two or more persons and is governed by the laws of the state in which it is formulated.

Thus, if taxpayers run a single-member LLC, they need to file Form 1040 Schedule C, unless they treat the domestic LLC as a corporation. Note that for federal income tax purposes, a single-member domestic LLC is not treated as a separate entity.

Further, if taxpayers run a single-member LLC, they must file employment tax returns using the LLC’s name and Employer Identification Number (EIN) rather than their own name and EIN. They must file tax returns with LLC’s name and EIN even if the LLC is not treated as a separate entity for federal income tax purposes.

c. Qualified Joint Venture

If the taxpayers and their spouses jointly own and operate an unincorporated business and share in the profits and losses, they are partners in a partnership.

The taxpayers and their spouses are partners whether or not they have a formal partnership agreement in place. In such a case, they need to file Form 1065 instead of Schedule C for their joint business activity.

However, taxpayers and their spouses may not have to file Form 1065 if they:

  • Enter into a Qualified Joint Venture
  • Wholly own the unincorporated business as community property and treat their business as a sole proprietorship

1. Qualified Joint Venture

Taxpayers and their spouses enter into a Qualified Joint Venture instead of a partnership if:

  • Each of them materially participates in the business.
  • They are the sole owners of the business
  • Taxpayers and their spouses file a joint tax return for the tax year.

To know whether the taxpayers and their spouses materially participate in the business, they must check out the instructions of schedule c line G to understand the rules related to material participation.

Further, if the taxpayer and his or her spouse decide to enter into a qualified joint venture, such a setup will allow them to avoid the complexity of filing Form 1065. However, it will give each of them credit for social security earnings on which retirement benefits, disability benefits, survivor benefits, and insurance (Medicare) benefits are based.

In most cases, entering into a qualified joint venture does not increase the total tax owed on the joint return.

Also note that if the spouses own and operate a business through an LLC, it does not qualify for the election of a qualified joint venture. Only if the spouses own and operate businesses as co-owners and not in the name of a state law entity, they are allowed to enter into a Qualified Joint Venture.

How To File Tax Returns As A Qualified Joint Venture?

First, each of the spouses must divide all items of income, gain, loss, deduction, and credit attributable to the business between themselves based on their interests in the business.

Each of the spouses must file a separate Schedule C or F. Note that each of the spouses must enter their share of the applicable income, deduction, or loss on the appropriate lines of their separate Schedule C of Form 1040.

Further, each of the spouses may also need to file a separate Schedule SE to pay their self-employment tax.

2. Community Income

The taxpayers and their spouses can also choose to wholly own an unincorporated business as community property under the community property laws of a state, foreign country, or U.S. possession. If they do so, they can treat their wholly-owned, unincorporated business as a sole proprietorship, instead of a partnership.

In such a case, they need to follow the following rules in order to report their income and deductions on the tax return.

  • If only one spouse participates in the business, then the income from that business is the self-employment earnings of the spouse who carried on the business.
  • If both spouses participate in the business, then the income and deductions are allocated to the spouses based on their distributive shares.

Is Schedule C Only For the Self-Employed?

A Schedule C must also be filed by a taxpayer who receives a W-2 form working as an employee for a company.

But such a taxpayer also works as a freelancer or a gig worker on any of the digital platforms and earns additional income apart from earning income working as an employee for a company or a firm.

These digital platforms may include businesses that provide access to ridesharing services, delivery services, on-demand labor, and repair services, crafts and handmade item marketplaces, property and space rentals, and much more.

Thus, such taxpayers must report the income they generate from freelancing or gig work separately on Form 1040 Schedule C. Note that if the taxpayers earn income as an employee also, they need to report such income on Form W-2.

However, there can be a scenario wherein the taxpayers earn additional income through freelancing or gig work without any intention of earning profits out of it or running it as a business. In such a case, the activity that the taxpayers are engaged in will be considered a hobby and not a business. Further, the taxpayers need not showcase the income earned by pursuing such a hobby on Form 1040 Schedule C.

However, they need to showcase the income generated from pursuing a hobby on Schedule 1, under Additional Income. Though, the taxpayers cannot claim any tax deductions on such an income.

When to File Schedule C?

Generally, taxpayers need to file their annual tax returns on day 15 of the fourth month after their fiscal year ends. Further, if day 15 turns out to be a Saturday, Sunday, or legal holiday, then the due date for filing the annual tax return is delayed until the next business day. Note that the tax return is considered filed on time if the taxpayer’s envelope is properly addressed, postmarked, and deposited in the mail by the due date.

Accordingly, taxpayers must file their Form 1040 Schedule C every year in April.

The taxpayers can request an automatic tax-filing extension that gives the taxpayer until October 15 to file a return. However, filing an extension does not mean that it grants any extension of time to the taxpayers for paying their taxes. This means taxpayers must estimate and pay any owed taxes by their regular due date to avoid any possible penalties. Further, taxpayers must file their extension request no later than their regular due date of filing returns.

How to Fill Out Schedule C?

There are five parts of Form 1040 Schedule C. These include:

Part I: Income
Part II: Expenses
Part III: Cost of Goods Sold
Part IV: Information On Your Vehicle
Part V: Other Expenses

Let’s understand each of the parts one by one.

Part I: Income

The following are the different components under Part I of Form 1040 Schedule C.

a. Gross Receipts Or Sales Schedule C Line 1

The taxpayers need to report all income they earned from their trade or business from all sources under gross receipts or sales.

They may use the specific Form 1099 to fill this section. Note that self-employed taxpayers may receive a specific Form 1099 from their payers. This is because the payers are obligated to provide information to the IRS for the payments they made to the self-employed taxpayers as a result of their trade or business through Form 1099.

Thus, the self-employed are required to fill out this Form and send it to the payers before the due date.

The taxpayers also need to enter their statutory employee income on line 1 of Schedule C and check the box on that line. Note that Social Security and Medicare tax must have been withheld from their earnings. Thus, such taxpayers do not owe self-employment tax on these earnings.

Further, the taxpayers need to file two Schedules C in case they had both self-employment income and statutory employee income.

b. Returns and Allowances Schedule C Line 2

The taxpayers need to report their sales returns and allowances on line 2.

Note that a sales return is a cash or a credit refund that you as taxpayers give to customers who returned defective, damaged, or unwanted products. Whereas, a sales allowance is not a cash or credit refund. Rather, it is a reduction in the selling price of products.

c. Subtract Line 2 From Line 1

In this section, the taxpayers need to deduct returns and allowances in Schedule C Line 2 from the gross receipts or sales from Schedule Line 1.

d. Cost of Goods Sold (From Schedule C Line 42)

Here, the taxpayers just need to mention the Cost of Goods Sold (COGS) calculated in Schedule C line 42.

e. Gross Profit (Subtract Line 4 From Line 3 )

In this section, all the taxpayers need to do is subtract the Cost of Goods Sold mentioned in Schedule C Line 4 from Line 2.

f. Other income, Including Federal and State Gasoline or Fuel Tax Credit or Refund

This section includes the business income not reported elsewhere in Part I of Schedule C. To know the income from other sources, the taxpayers need to check out the instructions of Form 1040 Schedule C.

g. Gross Income (Add Lines 5 and 6)

In this section, the taxpayers can calculate their Gross Income after adding Schedule C Line 5 and Line 6.

Part II: Expenses

a. Expenses Lines 8 to 27b

In Part II of Schedule C, the taxpayers can mention all the expenses that they have incurred to carry out their business or trade in the tax year in lines 8 to 27b. Some of these expenses include:

  • Advertising
  • Car and truck expenses
  • Commissions and fee
  • Contract labor
  • Depreciation
  • Insurance
  • Interest paid to banks and others
  • Legal and professional services
  • Office expenses
  • Rent or lease for vehicles, machinery, equipment, and other business property
  • Repairs and maintenance
  • Taxes and licenses
  • Travel and meals
  • Utilities

To know the complete list of business expenses that can be deducted from Gross Income, please refer to the instructions of Schedule C.

b. Expenses Lines 28 to 32

1. Part II Schedule C Line 28

This section showcases the total business expenses that taxpayers may have incurred during the tax year apart from the expenses for business use of the home. The taxpayers need to add lines 8 through 27 to get the total business expenses. Note that this section does not include the expenses incurred for business use of the home.

2. Part II Schedule C Line 29

This section showcases the tentative profit or (loss). To calculate the tentative profit or loss, the taxpayers need to subtract Schedule C line 28 from line 7.

3. Part II Schedule C Line 30

In this section, the taxpayers need to showcase the expenses that they incurred towards the home or part of the home that they used for carrying out their business or trade. There are certain limitations for deducting certain expenses for business use of the home. Taxpayers need to read the instruction carefully before filling out this section.

4. Part II Schedule C Line 31

If the gross income of the taxpayers is more than their expenses, including the expenses reported on line 30, the resulting figure is the Net Profit. To calculate the Net Profit, the taxpayers must deduct line 30 from line 29. Note that the taxpayers can showcase the Net Profit here only if they do not have prior year unallowed passive activity losses.

Also, in case the figure after deducting expenses from gross income is a Net profit, the taxpayers need to report this resulting figure of Net Profit, on both line 3 of Form 1040 Schedule 1 and Line 2 of Schedule SE. Provided the taxpayers received the income reported in Line 1 of Schedule C and their W-2 as income received as a statutory employee.

However, if the gross income of the taxpayers is less than their expenses, including the expenses reported on line 30, the resulting figure is the Net Loss. In such a case, the taxpayers must go to line 32 of Schedule C.

5. Part II Schedule C Line 30

To fill out this section, the taxpayers must check out the at-risk rules mentioned under Line 32 of the Schedule C instructions manual.

Part III: Cost of Goods Sold

This section spans from line 33 to line 42. The taxpayers who are engaged in a trade or a business wherein the production, purchase, or sale of merchandise is an income-producing factor need to fill out this section. Such taxpayers must take into account the inventories both at the beginning and end of the tax year.

Let’s understand each of the sections separately.

1. Schedule C Line 33

In this section, the taxpayers need to check the box for the method of inventory that they used to calculate their Cost of Goods Sold. Taxpayers can value their inventory either at cost or the lower of cost or market value or any other method of valuing inventory that is approved by the IRS.

2. Schedule C Line 34

In this section of Schedule C, the taxpayers need to give an explanation in case there was a change in determining quantities, costs, or valuations between opening and closing inventory. Also, they need to check the box that reads ‘Yes’. If there was no change, then taxpayers can simply check the box that reads ‘No’ and move further.

3. Schedule C Line 35

This section of Schedule C needs to be filled by the taxpayers if there is a difference between the opening entry of the current year and the closing inventory of the tax year.

This will happen in case the taxpayers change their method of accounting in the current year. In this scenario, the taxpayers need to refigure the last year’s closing inventory using a new method of accounting that they choose to use in the current year and then enter the result on line 35.

Also, the taxpayers need to attach an explanation in case there is a difference between last year’s closing inventory and the refigured amount. Further, they need to take the difference into account when figuring out their section 481(a) adjustment. It refers to the adjustment that taxpayers may have to make to prevent amounts of income or expense
from being duplicated or omitted.

4. Schedule C Line 36

In this section, the taxpayers need to showcase the purchases of raw materials less the cost of items withdrawn for personal use.

5. Schedule C Line 37

In this section, taxpayers need to enter the total cost of labor that has been incurred for the production of goods or for the rendering of services. It does not include the indirect costs which may involve expenses incurred for running the business.

The indirect costs are not directly related to the goods or the services that the taxpayers provide to their customers. Note that the cost of labor does not include any amounts that taxpayers pay to themselves. It involves the cost of labor that was incurred to produce goods or for providing services to the end users.

6. Schedule C Line 38

In this section, the taxpayers must showcase the total costs incurred towards any materials and supplies. Note that these materials and supplies are the ones other than those mentioned in Part II of Schedule C. Part II of Schedule C showcases the cost of materials and supplies that taxpayers have actually consumed and used in their business during the tax year. Such supplies and materials are not directly used for producing goods or for providing services.

7. Schedule C Line 39

This section of Schedule C includes the other costs that taxpayers may have incurred during the tax year by the taxpayers for running their businesses.

8. Schedule C Line 40

In this section, the taxpayers need to add lines 35 through 39 of Schedule C and report the resulting figure. The resulting figure is nothing but the sum of Opening Stock, Purchases, and Direct Expenses.

9. Schedule C Line 41

In this section, the taxpayers need to mention the cost of their closing inventory for the tax year.

10. Schedule C Line 42

In this section, the taxpayers need to deduct line 41 from line 40 to calculate the cost of goods sold. The Cost of Goods sold is nothing but opening stock + purchases + direct expenses – closing stock.

Part IV: Information On Vehicle

The taxpayers need to fill out this section of Schedule C only if they are claiming car or truck expenses on line 9 of Schedule C and are not required to file Form 4562 for this business. To know whether the taxpayers are required to file Form 4562, they must check out the Schedule C instructions under line 13.

Part V: Other Expenses

The taxpayers must include all the ordinary and necessary business expenses that have not been deducted elsewhere on Schedule C under this section. They need to list the type and amount of each expense separately in the space provided below this section. Add all the other expenses and enter that total amount on lines 48 and 27a.

The taxpayers need to ensure that they do not include the cost of business equipment or furniture; replacements or permanent improvements to the property; or any personal, living, and family expenses under this section. Further, they should also not include any contributions made towards charity. Also, taxpayers cannot deduct fines or penalties paid to a government for violating any law under this section.

Alan Chen, CPA at Freecashflow.io, helping eCommerce businesses with their tax and accounting

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