The second step of the Schedule C, after you have described your business, is to report the Gross Income for your business for the tax year. This is done by completing the Part I – Income section of the Schedule C. See the image below.
line 1: Gross Receipts or Sales summarizes the total gross income from receipts and/or sales the Business received during the current tax year. The income sources are:
- Personal Services you provided to clients, or Products you sold to customers, that had you generate an Invoice for those services and sales.
- You have some sort of paper trail, to prove the income and payments
- Cash you received for personal services performed or products you sold, that has no paper trail. Remember the IRS rule for income is “You must report all income, except income that is exempt by law.” No exceptions.
- Personal services income reported to you in box 7 of the form 1099-MISC. See this link for a sample form 1099-MISC Box 7.
line 2: Returns and Allowances lists any product-based refund you gave to your customers who purchased your products.
- Returns are a cash or credit refund you gave to customers who returned defective, damaged, or unwanted products.
- Allowances are a reduction in the selling price of products, instead of a cash or credit refund.
line 3 subtracts these Returns and Allowances from your Gross Receipts and Sales total, from line 1. This is called your Net Receipts.
line 4: Cost of Goods Sold is the total cost you incurred during the tax year to purchase and produce the inventory for your product sales. Include the expenses that went into the product that was actually sold to the Customer. The direct Supplies you purchased that went into or helped produce the product are also included, like dyes for fabric or thread to stitch the fabric. Any expense you incurred that went into the product, or allowed or assisted the manufacture of the product, is included in the Cost of Goods Sold calculations.
This is calculated in Part III – Cost of Goods Sold on page 2 of the Schedule C. Refer to the Blog post The 1040 – The Schedule C: Part III – Cost of Goods Sold for a more detailed explanation. An example:
- You started a new home business selling fashion accessories on the Internet in February of 2016. You therefore had no beginning inventory.
- During the course of the year you purchased $15,000 of the raw materials, fabric and trimmings required to manufacture your wholesale-priced fashion accessories, that you then sold through your Internet-based fashion business for a nice profit at regular retail prices. These include only the purchases that directly go into the finished product, ready for sale to your Customers. It would also include the $1,500 in fees you paid a Sample Maker who sewed your finished garments together.
- At the end of the business day on December 31st of this first year, the value of your remaining in-progress and finished – but still unsold wholesale inventory – was $4,500. This wholesale inventory is ready to be sold January 1st of the following year at the full retail price, as new orders begin in the New Year for your popular products.
- Your Cost of Goods Sold is therefore = $12,000, based on this formula:
- Inventory at beginning of the year in February 2016 = $0
- Raw materials purchased during the 2016 tax year = $15,000
- Sample Maker fees for 2016 tax year = $1,500
- $15,000 + $1,500 = $16,500
- Inventory at the end of the year on December 31st, 2016 = $4,500
- $16,500 minus $4,500 = $12,000 which is your Cost of Goods Sold
line 5: Gross Profit subtracts this Cost of Goods Sold value, from your line 3 Net Receipts. Line 3 again is your Gross Receipts minus your Returns and Allowances.
line 6: Other Income includes the following possible miscellaneous categories of income you had for your Business:
- Finance reserve income
- Which typically is the interest paid on this business reserve fund
- Scrap sales
- Scrap is the excess unusable material that is left over after a product has been manufactured. This leftover amount has minimal value, and is usually sold off for its material content costs.
- Bad debts you recovered, if you use the Accrual accounting method
- Interest payments you received, such as on notes or account receivable if you use the Accrual accounting method
- State gasoline or fuel tax refunds you received
- Credit for biofuel claimed on form 7478
- Credit for biodiesel and renewable diesel fuels on form 8864
- Credit for federal tax paid on fuels
- Prizes and awards related to your business
- Any other kind of miscellaneous income your business received
Line 7: Gross Income adds the line 6 Other Income total and the line 5 Gross Profit, to arrive at the final Gross Income total for your business. This is the “Bottom Line” number that states the final income your business generated for the current tax year.
Click the hyperlink below for the next blog post that explains how to list your Self-Employment Expenses reported on the Schedule C.
The 1040: The Schedule C: Part II- Expenses
Feel free to comment on these blog posts, or send me an email at Mike@TaxesAreEasy.com
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This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any tax transaction or filing any tax form.