What Does Business Income Mean?

What Does Business Income Mean?
Any income that is realized as a result of business activity. Business income is a type of earned income, and is classified as ordinary income for tax purposes.

Business income can be offset with business expenses and business losses. It can be either positive or negative in a given year.

Many Americans do not work for someone else-they earn their livings by running their own business. In this course you will learn how to prepare tax returns for self-employed people, except for farmers. You will use Schedule C. Profit or Loss From Business. Certain small business owners may qualify to use Schedule C.

While Schedule C may look a bit complicated at first glance, keep in mind that it is based on a simple formula: gross receipt (the money taken into a business) minus expenses equals net profit or loss.

Also you'll find out how self-employed taxpayers obtain social security and medicare coverage by the payment of self-employment tax. For this purpose, you'll use Schedule SE, Self-Employment Tax.

BUSINESS INCOME AND EXPENSES

Self-employed individuals are their own bosses. They decide when, how, and where to work, obtain their own jobs or sales, pay their own expenses, and receive social security and medicare coverage through payment of self-employment tax.

Sole Proprietorship - Which is a business owned by one individual, who files Schedule C with Form 1040.

Partnership - Is a business owned by two or more individuals.

If a married couple operate a business that is not set up as a partnership or corporation, the business is considered to belong to the spouse with the greater investment in labor and/or money.

No part of the "salary" of the proprietor is deducted anywhere on Schedule C. A proprietor cannot issue a Form W-2 or withhold and pay payroll taxes on amounts he withdraws from the business even if these amounts are designated as wages. For employees, payroll taxes should be withheld and remitted to the taxing agencies and Form W-2 must be prepared and furnished to the taxing agencies and the employees. A proprietor will file Form 1040-ES to pay his estimated income and self-employment (SE) tax liability.

SCHEDULE C

Heading
The heading of Schedule C request information about the business. The following explanations will help you complete this portion of the form.

Principal business or profession
Is the business or professional activity that provided the principal source of income. Give the general field or activity and type of product sold or produced or client served. Examples are "retail sales of household products" and "preparation of tax returns for individuals"

Business name and address.
Use the actual name of the business or, if there is no business name, leave line C blank. The business address on line E is the address from which the business is conducted. Enter the street address (including suite or room number), city, state, and ZIP, not a box number. Line E ay be left blank if the taxpayer conducted the business from his home and that address is the shown on Form 1040.

Employer ID number (EIN)
Is required if the business has any employees or is required to file alcohol, firearms, excise, or tobacco tax returns, or if the proprietor has a Keogh retirement plan. The proprietor may obtain an identification number by filing Form SS-4, which is available from any IRS office.

Accounting method.
The most common methods of accounting are the cash and accrual methods. Under the accrual method of reporting income, total sales and total charges for services in the tax year are included in income even though payment may be received in another tax year. Under the cash method, only income actually or constructively received during the year is included.

It is also possible to use a hybrid method. If the production, sale, or purchase of merchandise is an income producing factor, the proprietor must keep an inventory and use the accrual method in computing gross profit.

Line G. A proprietor materially participates when he is involved in the business in a substantial way on a regular basis. The answer to this question is important because if the proprietor does not materially participate, any loss from the business is considered a passive loss and can, generally, only be deducted currently against passive income. You'll learn more about passive income and losses later in the course.

Line H. Mark this box if the business was started or acquired during the tax year, or if the business is re-opening after a temporary close and no Schedule C (or C-EZ) was filed the previous tax year.

Income

Gross receipt include the gross amount of cash receipts and the fair market value of any property and services the proprietor receives in exchange for the goods or services he sells. Depending upon the type of business, the proprietor may receive one or more Forms 1099-MISC, reporting some or all of the income he has made from self-employment. This income should be included as part of his gross receipts.

Example: George Yosores delivers newspapers as an independent contractor for the LA news. He receives his share of the profits directly from the newspaper, which handles all subscription and billing activities. George's  Form 1099-MISC and will report the income on line 1 of his Schedule C.

If a business is required to collect state or local sales taxes, the taxpayer may either report gross receipts minus any sales remitted to the taxing agencies with other deductible taxes on 23, Schedule C.

Note: Keep in mind that if the business involves an inventory, gross receipts and the cost of goods sold must be computed using the accrual accounting method. Thus, accounts receivable for such businesses must be included in gross receipts even if not collected by the end of the year.

Returns and allowances 
Are amounts included in gross receipts that were refunded to customers who returned merchandise for refund or who were given a partial refund because they received damaged merchandise or for other similar reasons. These amounts are subtracted from gross receipts.

Cost of goods sold
If the production, purchase, or sale of merchandise produces income for the business, Schedule C, Part III, on page 2, must be used to compute the cost of good sold or manufactured.

Gross profit
In Part I, is gross receipts minus returns and allowances and cost of goods sold.

Other Income
Includes income from sales of scrap, interest received on customer accounts receivable, and other kinds of miscellaneous income received by the trade or business.

Expenses

Operating expenses are the ordinary and necessary expenses of conducting a business, trade, or profession. These expenses are deducted in Part II, Schedule C. We'll discuss them in the order they appear on the form.

Advertising
These are expenses to promote the business, including newspaper ads, flyers (including the cost of distributing them), television and readio promotions, Internet banners, and business cards.

Bad debts from sales or services
Customers accounts receivable and notes receivable that are definitely known to be worthless are business bad debts and are deductible if the income was included in gross income. Generally, only accrual-method taxpayer is ordinarily not entitled to claim a deduction for business bad debt deduction. A cash-method taxpayer is ordinarily not entitled to claim a deduction for business bad debts because sales are not included in gross income until payment is received.


Example: Adrelyn Yosores runs a bookkeeping business. She performed $500 worth of work for a client who left town without paying the bill. Because she uses the cash method of accounting, she did not inclede the $500 in her income because the client had not yet paid. Thus, even though her client disappeared without paying, she cannot take a deduction on line 9 because the $500 was never included in income.