Small business owners who operate as sole proprietors, and people who receive income as independent contractors, are required to fill out the 1040 Schedule C form as part of their annual tax filing. Schedule C income is separate from income received as salary and is subject to different tax rates; this form also allows you to itemize business-related deductions from your income.
- Lines A through H of the 2009 form are mostly straightforward: Fill out your name, Social Security number and the address and type of your business. Leave the Employer Identification Number (line D) blank if you do not have one. Most small businesses use the cash method (line F), but check the accrual box if you use that method of accounting (booking sales and expenses when they are incurred, not when they are paid).
For line G, you "materially participated" in the business if you did 500 hours of work in its ongoing operations; investor activity generally does not qualify as material participation. There is a seven-step test for material participation; see page C-3 of the Schedule C instructions for details. - Enter your gross receipts on line 1; this is the total income of your business or contracting, before expenses. Line 2, returns and allowances, are for monies which were received and then returned to your customers and clients (i.e., due to a sales return). Cost of goods, line 4, refers solely to the expense of raw materials used to create your products; service-based businesses should leave this at zero, and subtract the expenses for materials used in Part II. Line 6, other income, refers to business income from non-sales activities, such as interest, recovery of bad debt and other sources; see page C-4 of the instructions for a checklist of income to include here.
- Itemize your expenses for your business or contracting here. It is important to note there are two major errors which can be made in this section: It is common for people to over-report expenses in order to minimize their taxes, or to accidentally under-report expenses because they are not aware what they are able to deduct. For example, if you do not keep receipts for meals during business-related travel, you can take a standardized expense instead. See pages C-4 through C-7 for details--and consider consulting with a tax professional if you think it might reduce your overall taxes.
If you have a separate part of your home dedicated to your business, you can deduct these costs in line 30. Note that this requires adding form 8829 to your return, and may increase your chance of being audited if your deduction is deemed too high. In line 31, you calculate your final profit or loss from the year, which you enter on your 1040 form. - These pages may be left blank if you are not taking these expenses; otherwise, parts III and IV are required supplementary information for these line items. Part V can be used for any expenses which do not fit into the categories of Part II.
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