This chapter shows how two sole
proprietors fill out their income
tax returns. Susan J. Brown reports
her net profit from her business on
Schedule C. She cannot use Schedule
C-EZ. Stanley Price reports his net
profit from his business on Schedule
C-EZ.
Preparing the Return
for Susan J. Brown
Susan J. Brown owns and
operates Family Fashions, a
ready-to-wear clothing shop. She
uses an accrual method of
accounting and files her return
on a calendar year basis.
Five employees worked in her
shop during the year. She filed
all the necessary employment tax
forms and made the required tax
deposits. See Publication 15
(Circular E), Employer's Tax
Guide.
Schedule C
First, Susan fills in the
information required at the
top of Schedule C. She
starts by entering her name
and social security number.
Then she completes lines A
through H.
Line A.
She enters her
principal business
activity which is found
on page C-9 of the
Instructions for
Schedule C. Susan
locates the major
business category that
describes her business.
She reads down the items
under Retail
Trade to find Family
clothing stores.
Line B.
She enters 448140,
which is the 6-digit
business code for a
family clothing store.
She found the code on
page C-9 of the
instructions for
Schedule C.
Line C.
She enters the name of
her businessFamily
Fashions.
Line D.
She enters her
employer identification
number (EIN). She has to
have an EIN because she
has employees. For
information about EINs,
see
Identification
Numbers in
chapter 1.
Line E.
She enters her
business address.
Line F.
She checks box 2 for
accrual method of
accounting.
Line G.
Susan checks Yes
because she materially
participated in her
business during the
year. The material
participation rules are
explained in the
instructions for
Schedule C.
Line H.
She leaves the box
blank because she did
not start or acquire her
business during the
year.
Part I.
Income and
Part III.
Cost of
Goods Sold
Susan enters items of
income in Part I.
Line 1. Susan
enters her total
sales of $410,000
for the year.
Line 2. She
enters the refunds
she gave on
merchandise her
customers returned,
as well as other
adjustments she made
to customers'
purchases. They
total $1,442.
Line 3. She
subtracts line 2
from line 1 and
enters $408,558.
Line 4. Susan
uses Part III on
page 2 of Schedule C
to figure her cost
of goods sold
($239,349).
Part III, line
33. She
checks box a,
Cost, to show the
method used to value
her inventory.
Part III, line
34. She
checks box No
since there were no
inventory method
changes.
Part III, line
35. Her
inventory at the
beginning of the
year, $42,843, is
the same as her
inventory at the end
of last year. This
figure matches the
amount on Part III,
line 41, of her last
year's Schedule C.
Part III, line
36. The
total cost of goods
she bought to sell
to customers, minus
the cost of the
goods she returned
to her suppliers,
was $241,026. From
this stock, she
withdrew clothing
and accessories for
her own use that
cost $774. She
subtracts the cost
of these items from
her total purchases
to figure net
purchases of
$240,252.
Part III, line
40.
Because Susan did
not have any costs
to enter on lines 37
through 39, she adds
her net purchases
(line 36) to her
beginning inventory
(line 35) and enters
$283,095 on line 40.
This sum is the
total goods Susan
had available for
sale during the
year.
Part III, line
41.
Susan's inventory
at the end of the
year was $43,746.
Part III, line
42. Susan
subtracts her
inventory at the end
of the year (line
41) from the goods
that were available
for sale (line 40)
to get the cost of
goods sold during
the year. She enters
$239,349 on line 42
and on line 4 of
Part I. For more
information on
inventories, see
chapter 2. For more
information on cost
of goods sold, see
chapter 6.
Line 5. Susan
subtracts the cost
of goods sold,
$239,349 (line 4),
from the amount on
line 3, $408,558,
and enters $169,209
on line 5.
Line 7.
Because Susan did
not have any income
to report on line 6,
the gross income is
the same as the
gross profit (line
5). She enters
$169,209 on line 7.
Part II.
Expenses
Susan enters her
expense items in Part
II.
Line 8. Susan
paid $3,500 for
advertising.
Line 9. She
used her van 75% for
business during the
year. She spent a
total of $3,000 for
gas and oil. Other
van expenses include
$950 for insurance,
$1,083 for repairs
and upkeep, and $100
for tags. She
multiplies the sum
of these expenses
($5,133) by 75% and
enters the total
($3,850) on line 9.
See
Car and Truck
Expenses in chapter 8.
Line 13. Susan
enters the $12,066
depreciation from
Form 4562, discussed
later.
Line 15. Susan
enters $1,400 for
insurance on her
business property
(van insurance is
included in line 9).
The deduction is
only for premiums
that give her
coverage for the
year. See
Insurance in chapter 8.
Line 16b.
Susan had borrowed
money to use in her
business. The
interest on these
loans was $2,633 for
the year. See
Interest in chapter 8.
Line 18. Susan
enters $500 for
postage and computer
supplies.
Line 20b. Her
rent for the store
was $1,000 a month,
or $12,000 for the
year. See
Rent Expense
in
chapter 8.
Line 22. She
spent $1,203 on
supplies.
Line 23. Susan
renewed her business
license and paid
property tax on her
store fixtures. She
also paid the
employers share of
social security and
Medicare taxes for
her employees and
paid state and
federal unemployment
taxes. She enters
the total of all
these taxes, $5,727,
on this line. See
Taxes in chapter 8.
Line 25.
Susan's total
expense for heat,
light, and telephone
for the year is
$3,570.
Line 26. Susan
paid her employees a
total of $59,050 for
the year. She does
not include in wages
any amounts she paid
to herself or
withdrew from the
business for her own
use. See
Employees' Pay
in
chapter 8.
Line 27. Susan
enters the total of
her other business
expenses on this
line. These expenses
are not included on
lines 8 through 26.
She lists the type
and amount of the
expenses separately
in Part V of page 2
and carries the
total ($8,557) to
line 27. In Part V,
she enters bad debts
of $479, bank
service charges of
$180, Chamber of
Commerce dues of
$60, credit card
fees of $6,000,
trash removal
expenses of $1,600,
and window washing
of $238 for a total
of $8,557. This
amount is entered on
line 48 and Part I,
line 27. See chapter
8 for expenses you
can or cannot
deduct.
Line 28. Susan
adds all her
expenses listed in
Part II and enters
$114,056 on this
line.
Line 29. She
subtracts her total
expenses (line 28)
from her gross
income (line 7).
Susan has a
tentative profit of
$55,153.
Line 30. Susan
did not use any part
of her home for
business, so she
does not make an
entry here. For
information about
business use of the
home, see
Business Use of
Your Home in chapter 8.
Line 31. Susan
has a net profit of
$55,153 (line 29
minus line 30). She
enters her net
profit here, on line
12 of Form 1040, and
on Schedule SE (Form
1040), Section A,
line 2.
Line 32. Susan
does not have a
loss, so she skips
this line. If she
had a loss and she
was not at
risk for all
her investment in
the business, the
amount of loss she
could enter on line
12 of Form 1040
might be limited.
For an explanation
of an investment at
risk, see
the Schedule C
instructions for
line 32.
Form 4562.
Depreciation and
Amortization
Susan figures her
depreciation for the year on
Form 4562. In June 2004, she
purchased a computer and
printer ($3,050),
off-the-shelf software
($600), and a new van
($18,667). In September
2004, she purchased a sewing
machine ($1,236) to use in
her store. The computer,
printer, and sewing machine
are used 100% for business.
Before Susan can make
decisions concerning the
types of depreciation to
take, she must first
determine the class of the
property. Computers and
peripheral equipment are
5-year property. Vans are
5-year property. Sewing
machines do not have a
designated class life, so
they are considered to be
7-year property.
Susan fills in the
information required at the
top of Form 4562. She enters
her name, the name of her
business, and her social
security number.
Lines 1
and 3. The maximum
amount which can be
claimed as a section 179
deduction ($102,000) is
shown on line 1. The
threshold cost of
section 179 property
before reduction in
limitation ($410,000) is
shown on line 3.
Line 2.
Susan elects to claim
a section 179 deduction
for the sewing machine
($1,236) and for the
off-the-shelf software
($600). She enters
$1,836.
Line 4.
She subtracts line 3
from line 2. Since line
2 is less than line 3,
she enters -0-.
Line 5.
She subtracts line 4
from line 1 and enters
$102,000.
Line 6.
She enters off-the-shelf
software on the
first line in column
(a), and enters $600 in
columns (b) and (c). She
enters sewing
machine on the
second line of column
(a), and enters $1,236
in columns (b) and (c).
Line 8.
There is no entry in
line 7 since she is not
claiming a section 179
expense deduction on any
listed property. She
totals the amounts in
column (c), lines 6 and
7, and enters $1,836.
Line 9.
She selects the
smaller of either line 5
($102,000) or line 8
($1,836) and enters
$1,836.
Line
11. Susan must
make a computation for
line 11. Since she has
no other business
income, she can add the
$1,836 taken as a
section 179 deduction to
the net profit shown in
line 31 of Schedule C
($55,153) to arrive at a
total business income of
$56,989. Since this
amount is less than the
amount on line 5, she
enters $56,989 on line
11. See
Depreciation
in chapter 8.
Line
12. She adds lines
9 and 10 for a total of
$1,836. Since this
amount is smaller than
the amount on line 11,
she can claim the total
elected cost of the
section 179 deductions.
She enters $1,836.
Line
14. Susan elects
to take the 50% special
depreciation allowance
on the 5-year property
(the computer, printer,
and van). The van is
considered listed
property so it is
reported in Part V, line
25. The computer and
peripheral equipment are
not considered listed
property since they are
used 100% for business
and are used only at a
regular business
establishment. The
computer and printer are
used 100% for business,
so she multiplies the
cost of $3,050 ($2,600 +
$450) times 50% to
arrive at the amount
allowed for the special
depreciation allowance
($1,525) which is
entered on line 14.
Part V, line 24a.
She checks the Yes
block since she has
supporting documentation
for the business use
claimed.
Part V, line 24b.
She checks the Yes
block since the evidence
is written.
Part V, line 25.
Since the van is used
75% for business, she
must multiply the cost,
$18,667, times 75% to
arrive at the amount
allowed for business
use, $14,000. Then she
multiplies this amount
times 50% to arrive at
the amount allowed for
the special depreciation
allowance for the van.
She enters $7,000 on
line 25.
Part V, lines 26.
On June 20, Susan
bought the new van that
she placed in service in
her business. She enters
USA 280 VAN on line 26,
column (a); 06/20/04 in
column (b); 75 in column
(c); 18,667 in column
(d); 7,000 in column
(e); 5 yr in column (f);
200 DB/HY in column (g);
1,400 in column (h); and
-0- in column (i). The
van weighs over 6,000
pounds; therefore, it is
not a passenger
automobile and is not
subject to the special
deduction limits. The
van is 5-year property.
She figures depreciation
using the 200% declining
balance method and
applying the half-year
convention under MACRS.
The van cost $18,667.
Her basis for
depreciation is 75% of
$18,667, or $14,000,
because only 75% of the
total miles she drove
during the year were
business miles. Since
she elected to use the
50% special depreciation
allowance, she must
reduce her basis in the
van ($14,000) to $7,000.
Susan does not elect to
deduct any part of the
cost of the van as a
section 179 deduction.
She used Table A-1 in
Publication 946 to
determine the percentage
she is allowed to take
for the first year
(20%). She multiplies
$7,000 by 20% (.20) to
arrive at $1,400. She
enters $1,400 on line
26, column (h).
Part V, line 28.
She totals the amounts
shown in column (h)
($7,000 + $1,400) and
enters $8,400 on line 28
and Part IV, line 21.
Part V, lines 30 through
36. Because
Susan is a sole
proprietor, she must
complete lines 30
through 36. In column
(a) she enters 7,500 on
line 30; 2,025 on line
31; 475 on line 32; and
10,000 on line 33. She
checks Yes
to lines 34, 35, and 36
because the van was
available for personal
use, was used primarily
by Susan, and she had
another vehicle.
Line
19b. Since Susan
claimed the 50% special
depreciation allowance
for the computer and
peripheral equipment she
must reduce the basis by
the amount claimed
($1,525). Computers and
peripheral equipment are
5-year property. She
uses the Modified
Accelerated Cost
Recovery System (MACRS)
to figure depreciation.
Susan enters $1,525 in
column (c), 5 yr in
column (d), HY in column
(e), 200 DB in column
(f), and $305 in column
(g). She used Table A-1
in Publication 946 to
determine the percentage
she is allowed to take
for the first year
(20%). She multiplies
$1,525 by 20% (.20) to
arrive at $305. See
Publication 946 for
information about MACRS.
Line
21. Susan had
carried $8,400 from line
28 to line 21.
Line
22. Susan has a
total depreciation
deduction of $12,066.
She enters her deduction
here and on line 13 of
Schedule C.
Schedule SE.
Self-Employment
Tax
After Susan prepares
Schedule C, she fills out
Schedule SE. She starts by
entering her name and social
security number at the top
of the schedule. Then she
reads the chart on page 1 of
the schedule, which tells
her she can use Section
AShort Schedule SE to
figure her self-employment
tax. She fills out the
following lines in Section
A.
Lines 2
and 3. She enters
$55,153. This is her net
profit from line 31 of
Schedule C.
Line 4.
She multiplies $55,153
by 92.35% (.9235) to get
her net earnings from
self-employment
($50,934). This is her
net profit subject to
self-employment tax.
Line 5.
Because the amount on
line 4 is less than
$87,900, Susan
multiplies the amount on
line 4 ($50,934) by
15.3% (.153) to get her
self-employment tax of
$7,793. She enters that
amount here and on line
57 of Form 1040.
Line 6.
She multiplies the
amount on line 5 by 50%
(.5) to get her
deduction for one-half
of self-employment tax
of $3,897. She enters
that amount here and on
line 30 of Form 1040.
Form 1040
Susan fills out Form 1040
as follows:
Name,
address, and social
security number.
Susan enters her name,
home address, and social
security number.
Presidential election
campaign fund.
Susan chooses to have
$3 go to this fund. She
checks the box next to Yes.
Line 1.
Susan checks the box
on this line because she
is filing as single.
Lines
6a and 6d. Susan
claims an exemption for
herself. She checks the
box next to Yourself
and enters 1
in the far right-hand
entry space. She also
enters 1
in the box on line 6d.
Line
8a. Susan enters
$788 of taxable interest
credited to her personal
savings account for the
year.
Line
12. She enters her
business net profit of
$55,153 from line 31 of
Schedule C.
Line
22. Susan adds the
amounts on lines 7
through 21 and enters
the total, $55,941.
Line
30. Susan enters
one-half of her
self-employment tax
($3,897). She got this
amount from line 6 in
Section A of Schedule
SE.
Line
31. Susan enters
$4,800 as her deduction
for her health insurance
premiums for the year.
Her health insurance
plan was established
under her business.
Line
32. Susan enters
her simplified employee
pension (SEP) deduction
of $2,441. She figures
her deduction by using
Publication 560.
Line
35. Susan adds the
amounts on lines 23
through 34a and enters
the total, $11,138.
Line
36. Susan
subtracts the amount on
line 35 from the amount
on line 22 to arrive at
her adjusted gross
income, $44,803. She
also enters this amount
on line 37.
Line
39. She enters
$4,850. This is the
standard deduction for a
single filer.
Line
40. Susan
subtracts line 39 from
line 37 to get $39,953.
Line
41. She multiplies
$3,100 by the number of
exemptions claimed on
line 6d to get her total
exemptions, $3,100.
Line
42. Susan
subtracts line 41 from
line 40 to get her
taxable income, $36,853.
Line
43. Susan uses the
Tax Table in the Form
1040 instructions to
figure her income tax.
In the Tax Table she
looks for the income
bracket that includes
$36,853. She finds the
bracket for incomes of
at least $36,850 but
less than $36,900 and
sees that the tax for a
person filing as single
is $5,956. She enters
this amount here.
Lines
44 and 45. Because
she does not owe
alternative minimum tax,
she leaves line 44 blank
and enters $5,956 on
line 45.
Lines
55 and 56. Because
Susan does not have any
of the credits listed on
lines 46 through 54, she
enters -0- on line 55
and $5,956 on line 56.
Line
57. She enters
$7,793 from line 5 in
Section A of Schedule
SE.
Line
62. Susan adds the
amounts on lines 56
through 61 and enters
the total, $13,749.
Line
64. She enters
$13,000 of estimated tax
payments she made for
the year.
Line
70. She enters
$13,000.
Line
74. Susan
subtracts line 70 from
line 62 to get the
amount of tax she owes
and enters $749 on line
74. She writes a check
payable to the United
States Treasury for
$749. On the check she
writes her social
security number, her
daytime telephone
number, and 2004
Form 1040. Her
name and address are
printed on the check.
She sends her payment
with Form 1040-V,
Payment Voucher (not
illustrated). She fills
out that form and sends
it to the IRS with her
check and tax return.
Signing
and assembling the
return. She signs
her name and enters the
date signed, her
occupation, and a
daytime telephone
number. Because she does
not want to designate a
third party to discuss
her return with the IRS,
she checks the No
block in the
Third Party Designee
area just above the
signature area. She
assembles her original
Form 1040, Schedules C
and SE, and Form 4562 in
that order. (See Attachment
Sequence No. in
the upper right corner
of each schedule or
form.) Then she makes a
copy of the return for
her records. Finally,
she mails it to the IRS.
Stanley Price owns and
operates Stan's Barber Shop. He
has been in business for 32
years. Stanley uses the cash
method of accounting and files
his return on a calendar year
basis.
Schedule
C-EZ
Stanley uses Schedule
C-EZ to report the net
profit from his business
because he meets all of the
requirements listed in Part
I of the schedule. Stanley
enters his name and social
security number at the top
of the schedule.
Part I.
General
Information
Stanley fills out
Part I as follows:
Line A. He
enters his principal
business.
Line B. He
enters 812111, which
is the 6-digit
business code for a
barber shop. He
found the code on
page C-8 of the
instructions for
Schedule C. Stanley
locates the major
business category
that describes his
business. He reads
down the items under
Other
Services to
find 812111Barber
shops.
Line C. He
enters the name of
his businessStan's
Barber Shop.
Line D.
Stanley leaves
this line blank. He
does not have an
employer
identification
number (EIN) because
he is not required
to have one. For
information about
EINs, see
Identification
Numbers
in chapter 1.
Line E. He
enters his business
address.
Part II.
Figure Your
Net Profit
Stanley fills out
Part II as follows:
Line 1. Gross
receipts.
Stanley enters his
gross receipts from
cutting hair. They
include the amounts
he charged for
haircuts and all the
tips received from
his customers. The
total for the year
was $29,500.
Line 2. Total
expenses.
Stanley enters his
expenses for the
year. They total
$5,000 and consist
of the following.
$545 for
advertising
in the local
newspaper.
$1,675
for
supplies.
$250 for
business
licenses.
$2,530
for
utilities
(electricity
and water).
Line 3. Net profit.
Stanley subtracts
his total expenses
($5,000) from his
gross receipts
($29,500) to get his
net profit of
$24,500. He enters
his net profit here,
on line 12 of Form
1040, and on line 2,
Section A, of
Schedule SE (Form
1040).
Part III.
Information
on Your
Vehicle
Stanley leaves this
part blank because he is
not deducting car or
truck expenses.
Schedule SE.
Self-Employment
Tax
After Stanley prepares
Schedule C-EZ, he fills out
Schedule SE. He starts by
entering his name and social
security number at the top
of the schedule. Then he
reads the chart on page 1 of
the schedule, which tells
him he can use Section
AShort Schedule SE to
figure his self-employment
tax. He fills out the
following lines in Section
A.
Lines 2
and 3. He enters
$24,500. This is his net
profit from line 3 of
Schedule C-EZ.
Line 4.
He multiplies $24,500
by 92.35% (.9235) to get
his net earnings from
self-employment
($22,626). This is his
net profit subject to
self-employment tax.
Line 5.
Because the amount on
line 4 is less than
$87,900, Stanley
multiplies the amount on
line 4 ($22,626) by
15.3% (.153) to get his
self-employment tax of
$3,462. He enters that
amount here and on line
57 of Form 1040.
Line 6.
He multiplies the
amount on line 5 by 50%
(.5) to get his
deduction for one-half
of self-employment tax
of $1,731. He enters
that amount here and on
line 30 of Form 1040.
Form 1040
Stanley fills out Form
1040 as follows:
Name,
address, and social
security number.
Stanley enters his
name, home address, and
social security number.
Presidential election
campaign fund.
Stanley chooses to
have $3 go to this fund.
He checks the box next
to Yes.
Line 1.
Stanley checks the box
on this line because he
is filing as single.
Lines
6a and 6d. Stanley
claims an exemption for
himself. He checks the
box next to Yourself
and enters 1
in the far right-hand
entry space. He also
enters 1
in the box on line 6d.
Line
8a. Stanley enters
$440 of taxable interest
credited to his personal
savings account for the
year.
Line
12. He enters his
business net profit of
$24,500 from line 3 of
Schedule C-EZ.
Line
22. Stanley adds
the amounts on lines 7
through 21 and enters
the total, $24,940.
Line
25. Stanley enters
the $2,000 contribution
he made for the year to
his individual
retirement arrangement
(IRA). According to the
Form 1040 instructions,
he can deduct this
amount.
Line
30. Stanley enters
one-half of his
self-employment tax
($1,731). He got this
amount from line 6 in
Section A of Schedule
SE.
Line
35. Stanley adds
the amounts on lines 23
through 34a and enters
the total, $3,731.
Line
36. Stanley
subtracts the amount on
line 35 from the amount
on line 22 to arrive at
his adjusted gross
income, $21,209. He also
enters this amount on
line 37.
Line
39. He enters
$4,850. This is the
standard deduction for a
single filer.
Line
40. Stanley
subtracts the amount on
line 39 from the amount
on line 37 to get
$16,359.
Line
41. He multiplies
$3,100 by the number of
exemptions claimed on
line 6d to get his total
exemptions, $3,100.
Line
42. Stanley
subtracts the amount on
line 41 from the amount
on line 40 to get his
taxable income, $13,259.
Line
43. Stanley uses
the Tax Table in the
Form 1040 instructions
to figure his income
tax. In the Tax Table he
looks for the income
bracket that includes
$13,259. He finds the
bracket for incomes of
at least $13,250, but
less than $13,300 and
sees that the tax for a
person filing as single
is $1,634. He enters
this amount here.
Lines
44 and 45. Because
he does not owe
alternative minimum tax,
he leaves line 44 blank
and enters $1,634 on
line 45.
Lines
55 and 56. Because
Stanley does not have
any of the credits
listed on lines 46
through 54, he enters
-0- on line 55 and
$1,634 on line 56.
Line
57. He enters
$3,462 from line 5 in
Section A of Schedule
SE.
Page 1 of
Schedule SE
(Form 1040)
for Stanley
Price
Line
62. Stanley adds
the amounts on lines 56
through 61 and enters
the total, $5,096.
Line
64. He enters
$6,000 of estimated tax
payments he made for the
year.
Line
70. He enters
$6,000.
Lines
71 and 72a.
Stanley subtracts the
amount on line 62 from
the amount on line 70 to
arrive at the amount he
overpaid, $904. He wants
this amount refunded to
him so he enters it on
line 72a. The IRS will
send him a check for
this amount provided he
owes no other taxes,
child support, spousal
support, or certain
other federal nontax
debt. If Stanley wanted
the refund deposited
directly into his
checking or savings
account, he would have
had to complete lines
72b, c, and d.
Signing
and assembling the
return. He checks
the No
block under
Third Party Designee
because he does not want
to designate anyone,
signs his name and
enters the date signed,
his occupation, and a
daytime telephone
number. He assembles his
original Form 1040 and
Schedules C-EZ and SE in
that order. (See Attachment
Sequence No. in
the upper right corner
of each schedule or
form.) Then he makes a
copy of the return for
his records. Finally, he
mails it to the IRS.
