Q: Tax Playa, what are the rules for using the shorter business form? Is there a "standard deduction"?
Chris, Arlington VA
A: Unincorporated single-owner businesses (including LLCs) account for their taxes owed on their 1040s by attaching a Schedule C, Business Income or Loss. Under certain conditions, a much shorter form can be used: Schedule C-EZ, Net Profit from Business. This form is much easier to use, but can only be used by a limited scope of taxpayers...
For more information on this, see the Form and Instructions for Schedule C-EZ.
All trade or business income is taxable. If you are in business on your own and are not incorporated, you are taxed as a sole proprietor. Most often, you will receive a 1099-MISC reporting income received, but not always.
Against this income, you can deduct ordinary and necessary business expenses. This can include meals and entertainment, travel, supplies, utilities, a home office, business assets, an inventory, use of a vehicle, etc. Under normal circumstances, these expenses must be itemized and deducted.
Some taxpayers qualify to use the Schedule C-EZ, which is a much simpler way of reporting this income. There are only three lines of income to report (as well as general information on your vehicle if it was used as a business asset):
- Total self-employment income for the business;
- Aggregate ordinary and necessary business expenses (limited to the lesser of total self-employment income for the business or $5000, whichever is less);
- Net income from self employment (Line 1 minus Line 2)
Not surprisingly, this ridiculously-easy form cannot be used by everyone. Excluded taxpayers would have one or more of the following characteristics:
- You have business expenses of more than $5000. I suppose you could still file, but why would you?
- You use the accrual method of accounting (unlikely in most cases, since individuals are required to use the cash method of accounting).
- You carry an inventory. This needs to be tracked over multiple years, so this eliminates business owners dealing in actual goods.
- You had a net loss. The most the Schedule C-EZ can do is cancel out business income.
- You had more than one business as a sole proprietor or statutory employee (traveling salesman).
- You had employees during the year.
- You are required to file a 4562 asset depreciation form because you placed business assets into service this year (normally structures, computers, and furniture).
- You have a home office deduction. This requires a separate form.
- You have prior-year passive losses from the business.
Even more than the restrictions, it should not be used by everyone--in particular, those with more than $5000 in ordinary and necessary business expenses. This form is meant mostly for those with small amounts of business expenses and (probably) business income.
I also want to dispel a notion that has gotten out there: the Schedule C-EZ is not a "standard deduction" for business. Rather, it is a simplified method of reporting actual ordinary and necessary expenses incurred, within the limits listed above.
In any case, if you have a net profit from all self-employed activities of more than $400, you must also pay self-employment tax. The good news is that you take take three adjustments to income in this case:
- One-half of self-employment tax (roughly equating you with an incorporated business);
- Self-employed health insurance premiums paid;
- SEP, Simple, and Qualified Plans associated with your small business