You are a sole proprietor if you own an unincorporated business, including a limited liability company, by yourself. Report your income and expenses from your sole proprietorship on Form 1040, Schedule C (PDF), Profit or Loss From Business, or on Form 1040, Schedule C-EZ (PDF), Net Profit From Business.
You may use Schedule C-EZ to determine your net profit if you have only one sole proprietorship and you meet all the requirements listed in Part 1 of Schedule C-EZ. If you can use Schedule C-EZ, gross receipts and total expenses from your business are reported in Part II. The difference between gross receipts and total expenses you reported is your net profit. Report net profit on line 12 of your Form 1040 (PDF).
You cannot use Schedule C-EZ if your business expenses were more than $5,000, your business used a method of accounting other than the cash method, you deducted expenses for the business use of your home, you are required to file Form 4562 (PDF) , Depreciation and Amortization, for your business, you have prior year unallowed passive activity losses from your business, or if you had employees, a net loss, or inventory.
If you cannot use Schedule C-EZ, you must report your business income and expenses on Schedule C.
If you have more than one sole proprietorship business, or if you and your spouse have separate businesses, you must use a separate Schedule C for each business.
Report the income from your business in Part I of Schedule C and the expenses in Part II. If you make or buy goods to sell, use Part III to figure the cost of goods sold. The difference between total income and total expenses is your net profit or loss, which will be taken from Schedule C and entered on line 12 of your Form 1040.
Historically, a taxpayer has been required to use an accrual accounting method with regard to purchases and sales of merchandise whenever the taxpayer was required to account for inventories. In Revenue Procedure 2001-10, 2001-2 I.R.B. 272 and Revenue Procedure 2002-28, 2002-18 1.R.B. 815, the Commissioner has exempted some qualifying taxpayers from having to use an accrual accounting method and from having to account for inventories.
Revenue Procedure 2001-10 is available for use by "qualifying taxpayers." A qualifying taxpayer is a taxpayer (1) who has average annual gross receipts of $1,000,000 or less and (2) who is not a tax shelter within the meaning of Internal Revenue Code Section 448(a)(3).
Revenue Procedure 2001-10 provides detailed procedures for determining whether you satisfy the average annual gross receipts test. Review section 5 of Revenue Procedure 2001-10 for these procedures.
Revenue Procedure 2002-28, exempts "qualifying small business taxpayers" from the requirements to use the accrual accounting method and permits treatment of inventorial items as materials and supplies that are not incidental. You are a qualifying small business taxpayer if your average annual gross receipts are in excess of $1,000,000 but are not more than $10,000,000, and your principle business activity is an eligible business. Review Sections 3 and 4 of Revenue Procedure 2002-28 for the qualification requirements.If you are a qualifying taxpayer under Revenue Procedure 2001-10 or a qualifying small business taxpayer under Revenue Procedure 2002-28 you may choose to:
- Use the cash accounting method and treat your inventoriable items as inventory within the meaning of IRC Section 471,
- Use the cash accounting method and treat your inventoriable items as materials and supplies that are not incidental within the meaning of Treasury Regulation Section 1.162-3, or
- Use an accrual accounting method and treat your inventoriable items as materials and supplies that are not incidental within the meaning of Treasury Regulation Section 1.162-3.
You can also follow the historic rule, that is, use an accrual accounting method and treat your inventoriable items as inventory within the meaning of IRC Section 471.
Be aware that Revenue Procedure 2001-10 & Revenue Procedure 2002-28 specifically state when you can deduct the costs for the inventoriable items that are being treated as materials and supplies that are not incidental within the meaning of Treasury Regulation 1.162-3. In the case of a cash method taxpayer, the cost for these items cannot be deducted until the year in which (1) you sell the items or (2) you pay for them, whichever is later.
A taxpayer wishing to change to the cash method or to change its method of accounting for inventory under the rules in Revenue Procedure 2001-10 or Revenue Procedure 2002-28 must follow the provisions of Revenue Procedure 2002-9, 2002-3 I.R.B. 327.
If you use part of your home in your business, you should complete Form 8829 (PDF). For more information, refer to Publication 587, Business Use of Your Home (Including Use by Day-Care Providers), or to Business Use of Home.
Revenue Procedure 2003-75 added an inclusion amount for rented or leased vehicles, machinery, or equipment for a term of 30 days or more. For more information, refer to Publication 463.
If the total of your net earnings from all businesses is $400 or more, you must compute your self-employment tax on Form 1040 Schedule SE (PDF). For more information, refer to Publication 533, Self-Employment Tax, or refer to Self-Employment Tax.
If you are new in business, refer to Publication 583, Starting a Business and Keeping Records. Publication 334, Tax Guide for Small Business, has more information on income and expenses from a sole proprietorship; or refer to Tax Help for Small Businesses and Self-Employed, Tax Help for Small Businesses and the Self-Employed.