Schedule C – Business Income or Loss – How it is Used to Reduce Taxes

Schedule C is used to report earnings and losses from the operation of a sole proprietorship. Although the primary purpose is to let the IRS know what income you have from your business, you may also use schedule C to reduce your earned income.


The first section of schedule C, after the basic information, is the income section. This area is where you input information form earnings. This includes the gross receipt from sales or services, minus returns and cost of goods.


The next section is the expense section. There are many expense categories, such as advertising, vehicle expenses, contract labor, depreciation, legal and professional expense, office expense, taxes and licenses, utilities, supplies, wages, and several others.


After calculating income and expenses, you can determine whether your business made a profit. If you did make a profit, you input the income on form 1040. You will not only pay income tax on this amount, but you will also pay self-employment tax, which is roughly 15%. The reason for being charged an extra self-employment tax is for the government to receive a supplement for you not having social security and Medicare taxes withheld as an employee. This means your income as a sole proprietor may be taxed as much as 50% (35% for the highest tax bracket and 15% for the self-employment tax).


The real goal in running a sole proprietorship and filing schedule C is to minimize the amount of your taxable income. While a business must be run to receive a profit and any business that does not meet this qualification will be considered a hobby, you should utilize as many deductions as humanly possible to reduce the income from this source and reduce your tax burden.


So, this is how you avoid paying extra taxes using schedule C, but how do you actually reduce your existing tax obligation? The answer is in the loss. Any loss that you have on schedule C is reported on form 1040 and used to reduce our income level. As stated earlier, you must run the business for the purpose of making a profit; however, if you receive a loss, you still come out ahead of the game.


Example: Don works as a CPA and makes $70,000 per year. However, his wife, Linda, also sells cosmetics in a home-based business setting. When tax time comes, Don and Linda file a joint return, attaching schedule C to calculate Linda’s income from her business. However, after factoring in mileage, loan payments she received to obtain inventory, and other standard expenses, Linda realized she actually lost $11,000 for the year in her business.


Initially Don is upset; however, he then realizes how this may actually improve their tax situation. At $70,000, married filing jointly, the tax bracket for Don’s income is the 25% bracket. However, when you factor in the loss from Linda’s business, their income for the year is actually $59,000, because Linda’s loss reduces Don’s income. This lowers their tax bracket to 15%. This provides a tax savings of $2,710. Obviously a profitable business is preferred, but the loss of Linda’s business saved tax dollars in the end.

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