Small Business tax issues is complex. We recommend small businesses work closely with a Small Business tax professional.
Below is Small Business Tax information from the IRS:
33411063PTax Guide for Small Business(For Individuals Who Use Schedule C or C-EZ)Introduction3What's New for 20054What's New for 20065Reminders5Photographs of Missing Children5 1. Filing and Paying Business Taxes6 2. Accounting Periods and Methods12 3. Dispositions of Business Property17 4. General Business Credits19 5. Business Income21 6. How To Figure Cost of Goods Sold28 7. Figuring Gross Profit30 8. Business Expenses32 9. Figuring Net Profit or Loss4110. Self-Employment (SE) Tax4211. Your Rights as a Taxpayer4612. How To Get More Information48Index51
The purpose of this publication is to provide general information about the federal tax laws that apply to small business owners who are sole
proprietors and to statutory employees.
Are you self-employed?
You are self-employed if you carry on a trade or business as a sole proprietor or an independent contractor.
Sole proprietor.Sole proprietorDefinitions:Sole proprietor
A sole proprietor is someone who owns an unincorporated business by himself or herself. However, if you are the sole member of a domestic limited
liability company (LLC), you are not a sole proprietor if you elect to treat the LLC as a corporation.
Trade or business.Trade or business
A trade or business is generally an activity carried on to make a profit. The facts and circumstances of each case determine whether or not an
activity is a trade or business. You do not need to actually make a profit to be in a trade or business as long as you have a profit motive. You do
need to make ongoing efforts to further the interests of your business.
You do not have to carry on regular full-time business activities to be self-employed. Having a part-time business in addition to your regular job
or business may be self-employment.
Independent contractor.
People such as doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers, or auctioneers who are
in an independent trade, business, or profession in which they offer their services to the general public are generally independent contractors.
However, whether they are independent contractors or employees depends on the facts in each case. The general rule is that an individual is an
independent contractor if the payer has the right to control or to direct only the result of the work and not how it will be done. The earnings of a
person who is working as an independent contractor are subject to self-employment tax. For more information on determining whether you are an
independent contractor or an employee, see Publication 15-A, Employer's Supplemental Tax Guide.
Statutory employee.
A statutory employee
Statutory employeehas a checkmark in box 13 of his or her Form W-2, Wage and Tax Statement. Statutory employees use Schedule C
or C-EZ to report their wages and expenses.
Limited liability company (LLC).Limited liability company
A limited liability company (LLC) is an entity formed under state law by filing articles of organization. Generally, a single-member LLC is
disregarded as an entity separate from its owner and reports its income and deductions on its owner's federal income tax return. An owner who is an
individual may use Schedule C or C-EZ.
Husband and wife business.Husband and wife businessPartners, husband and wife
If you and your spouse jointly own and operate an unincorporated business and share in the profits and losses, you are partners in a partnership,
whether or not you have a formal partnership agreement. Do not use Schedule C or C-EZ. Instead, file Form 1065. For more information, see Publication
541.
Exception. If you and your spouse wholly own an unincorporated business as community property under the community property laws of a
state, foreign country, or U.S. possession, you can treat the business either as a sole proprietorship or a partnership. The only states with
community property laws are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. A change in your reporting
position will be treated as a conversion of the entity.
This publication does not cover the topics listed in the following table.
IF you need information about:THEN you should see:Corporations Publication 542FarmingPublication 225Fishermen (Capital Construction Fund)Publication 595PartnershipsPublication 541Passive activitiesPublication 925RecordkeepingPublication 583S corporationsInstructions for Form 1120S
What you need to know.
Table A (shown above) provides a list of questions you need to answer to help you meet your federal tax obligations. After each question
is the location in this publication where you will find the related discussion.
<ROM>Table A.</ROM>
<IMARK>What You Need To Know About Federal Taxes(Note. The following is a list of questions you may need to answer so you can fill out your federal income tax return. Chapters
are given to help you find the related discussion in this publication.) What must I know Where to find the answerWhat kinds of federal taxes do I have to pay? How do I pay them?See chapter 1.What forms must I file?See chapter 1.What must I do if I have employees?See Employment Taxes in chapter 1.Do I have to start my tax year in January? Or can I start it in any other month?See Accounting Periods in chapter 2.What method can I use to account for my income and expenses?See Accounting Methods in chapter 2.What kinds of business income do I have to report on my tax return?See chapter 5.What kinds of business expenses can I deduct on my tax return?See chapter 8.What kinds of expenses are not deductible as business expenses?See Expenses You Cannot Deduct in chapter 8.What happens if I have a business loss? Can I deduct it?See chapter 9.What must I do if I disposed of business property during the year?See chapter 3.What are my rights as a taxpayer?See chapter 11.Where do I go if I need help with federal tax matters?See chapter 12.
IRS mission.IRS mission
Provide America's taxpayers top quality service by helping them understand and meet their tax responsibilities and by applying the tax law with
integrity and fairness to all.
Comments and suggestions.Comments on publicationSuggestions for publication
We welcome your comments about this publication and your suggestions for future editions.
You can email us at
*taxforms@irs.gov. (The asterisk must be included in the address.) Please put Publications Comment on
the subject line. Although we cannot respond individually to each email, we do appreciate your feedback and will consider your comments as we revise
our tax products.
You can write us at the following address:
Internal Revenue Service
Business Forms and Publications Branch
SE:W:CAR:MP:T:B
1111 Constitution Ave. NW, IR-6406
Washington, DC 20224
We respond to many letters by telephone. Therefore, it would be helpful if you would include your daytime phone number, including the area code, in
your correspondence.
Tax questions.
If you have a tax question, visit
www.irs.gov or call 1-800-829-1040. We cannot answer tax questions at either of the addresses listed above.
What's New for 2005
The following are some of the tax changes for 2005. For information on other changes, see Publication 553, Highlights of 2005 Tax Changes.
At the time this publication went to print, Congress was considering legislation that would provide additional tax relief for individuals affected
by Hurricane Katrina, Rita, and Wilma. For more details, and to find out if this legislation was enacted, see Publication 4492.
Standard mileage rate.
The standard mileage rate for the cost of operating your car, van, pickup, or panel truck in 2005 is 40.5 cents a mile for all business miles
driven before September 1, 2005. The rate is 48.5 cents a mile for business miles driven after August 31, 2005, and before January 1, 2006. For more
information, see Car and Truck Expenses in chapter 8.
Self-employment tax.
The maximum net self-employment earnings subject to the social security part (12.4%) of the self-employment tax is $90,000 for 2005. For more
information, see Self-Employment (SE) Tax in chapter 1 and chapter 10.
Domestic production activities deduction.
You may be able to deduct up to 3% of your qualified production activities income from certain business activities. For more information, see Form
8903, Domestic Production Activities Deduction.
Increased section 179 deduction dollar limit.
The maximum section 179 deduction you can elect for property you purchased and placed in service beginning in 2005 has increased from $102,000 to
$105,000. For more information, see Publication 946.
New and revised credits.
The following credits were created or revised by recent legislation. Some are effective for tax year 2005 and some for 2006. See chapter 4 for a
complete list of the credits and the form numbers.
Alcohol fuel credit.
Alternative fuel vehicle refueling property credit.
Alternative motor vehicle credit.
Biodiesel and renewable diesel fuels credit.
Credit for increasing research activities.
Distilled spirits credit.
Energy efficient appliance credit.
Energy efficient home credit.
Investment credit.
Nonconventional source fuel credit.
Qualified railroad track maintenance credit.
Renewable electricity, refined coal, and Indian coal production credit.
What's New for 2006
The following are some of the tax changes for 2006. For information on other changes, see Publication 553, Highlights of 2005 Tax Changes.
Self-employment tax.
The maximum net self-employment earnings subject to the social security part of the self-employment tax increases to $94,200 for 2006.
Standard mileage rate.
The standard mileage rate for the cost of operating your car, van, pickup, or panel truck in 2006 is 44.5 cents a mile for all business miles. For
more information, see Car and Truck Expenses in chapter 8.
RemindersAccounting Methods.
Certain small business taxpayers may be eligible to adopt or change to the cash method of accounting and may not be required to account for
inventories. For more information, see Inventories in chapter 2.
Reportable transactions.
You must file Form 8886, Reportable Transaction Disclosure Statement, to report certain transactions. You may have to pay a penalty if you are
required to file Form 8886 but do not do so. You may also have to pay interest and penalties on any reportable transaction understatements. Reportable
transactions include (1) transactions the same as or substantially similar to tax avoidance transactions identified by the IRS, (2) transactions
offered to you under conditions of confidentiality for which you paid an advisor a minimum fee, (3) transactions for which you have, or a related
party has, contractual protection against disallowance of the tax benefits, (4) transactions that result in losses of at least $2 million in any
single tax year ($50,000 if from certain foreign currency transactions) or $4 million in any combination of tax years, (5) transactions resulting in
book-tax differences of more than $10 million on a gross basis, and (6) transactions with asset holding periods of 45 days or less and that result in
a tax credit of more than $250,000. For more information, see the Instructions for Form 8886.
Photographs of Missing Children
The Internal Revenue Service is a proud partner with the National Center for Missing and Exploited Children. Photographs of missing children
selected by the Center may appear in this publication on pages that would otherwise be blank. You can help bring these children home by looking at the
photographs and calling 1-800-THE-LOST (1-800-843-5678) if you recognize a child.
Filing and Paying
Business TaxesPaying:Business taxesFiling business taxes
This chapter explains the business taxes you may have to pay and the forms you may have to file. It also discusses taxpayer identification numbers.
Table 1-1 lists the benefits of filing electronically.
Table 1-2 lists the federal taxes you may have to pay, their due dates, and the forms you use to report them.
Table 1-3 provides checklists that highlight the typical forms and schedules you may need to file if you ever go out of business.
You may want to get Publication 509, Tax Calendars for 2006. It has tax calendars that tell you when to file returns and make tax
payments.
Publication505Tax Withholding and Estimated TaxForm (and Instructions)U.S. Individual Income Tax ReturnEstimated Tax for IndividualsProfit or Loss From BusinessNet Profit From BusinessSelf-Employment Tax
See chapter 12 for information about getting publications and forms.
Identification NumbersIdentification numbers
This section explains three types of taxpayer identification numbers, who needs them, when to use them, and how to get them.
Social security number (SSN).Social security number (SSN)
Generally, use your SSN as your taxpayer identification number. You must put this number on each of your individual income tax forms, such as Form
1040 and its schedules.
To apply for an SSN, use Form SS-5, Application for a Social Security Card. This form is available at Social Security Administration (SSA) offices
or by calling 1-800-772-1213. It is also available from the SSA website at
www.socialsecurity.gov.
Form:SS-5
Individual taxpayer identification number (ITIN).Individual taxpayer identification number (ITIN)
The IRS will issue an ITIN if you are a nonresident or resident alien and you do not have and are not eligible to get an SSN. In general, if you
need to obtain an ITIN, you must attach Form W-7, Application for IRS Individual Taxpayer Identification Number, with your signed, original, completed
tax return and mail both to the Philadelphia Service Center. The exceptions are covered in detail in the instructions for Form W-7 (Rev. January
2006). If you must include another person's SSN on your return and that person does not have and cannot get an SSN, enter that person's ITIN. The
application is also available in Spanish. The form is available from the IRS website at
www.irs.gov or you can call 1-800-829-3676 to order the form.
Form:W-7
An ITIN is for tax use only. It does not entitle the holder to social security benefits or change the holder's employment or immigration status.
Employer identification number (EIN).Employer identification number (EIN)
You must also have an EIN to use as a taxpayer identification number if you do either of the following.
Pay wages to one or more employees.
File pension or excise tax returns.
If you must have an EIN, include it along with your SSN on your Schedule C or C-EZ.
You can apply for an EIN:
Online by clicking on the EIN link at
www.irs.gov/businesses/small. The EIN is issued immediately once the application information is
validated.
By telephone at 1-800-829-4933 from 8:00 a.m. to 8:00 p.m. in your local time zone.
By mailing or faxing Form SS-4, Application for Employer Identification Number.
Form:SS-4
New EIN.
You may need to get a new EIN if either the form or the ownership of your business changes. For more information, see Publication 1635,
Understanding Your EIN.
When you need identification numbers of other persons.
In operating your business, you will probably make certain payments you must report on information returns. These payments are discussed under
Information Returns, later in this chapter. You must give the recipient of these payments (the payee) a statement showing the total amount
paid during the year. You must include the payee's identification number and your identification number on the returns and statements.
Employee.
If you have employees, you must get an SSN from each of them. Record the name and SSN of each employee exactly as they are shown on the employee's
social security card. If the employee's name is not correct as shown on the card, the employee should request a new card from the SSA. This may occur
if the employee's name was changed due to marriage or divorce.
Form W-4 is completed by each employee so the correct federal income tax can be withheld from their pay.
If your employee does not have an SSN, he or she should file Form SS-5 with the SSA.
Other payee.
If you make payments to someone who is not your employee and you must report the payments on an information return, get that person's SSN. If you
must report payments to an organization, such as a corporation or partnership, you must get its EIN.
To get the payee's SSN or EIN, use Form W-9, Request for Taxpayer Identification Number and Certification.
Form:W-9
A payee who does not provide you with an identification number may be subject to backup withholding. For information on backup withholding, see the
Form W-9 instructions and the General Instructions for Forms 1099, 1098, 5498, and W-2G.
Income TaxIncome tax:AboutTaxes:Income
This part explains whether you have to file an income tax return and when you file it. It also explains how you pay the tax.
Do I Have To File
an Income Tax Return?Income tax return, who must fileTax return:Who must file
You have to file an income tax return for 2005 if your net earnings from self-employment were $400 or more. If your net earnings from
self-employment were less than $400, you still have to file an income tax return if you meet any other filing requirement listed in the Form 1040
instructions.
How Do I File?Tax return:How to fileForm:1040
File your income tax return on Form 1040 and attach Schedule CSchedule CForm:Schedule Cor Schedule C-EZ.
Schedule C-EZForm:Schedule C-EZEnter the net profit or loss from Schedule C or Schedule C-EZ on page 1 of Form 1040. Use Schedule C to figure
your net profit or loss from your business. If you operated more than one business as a sole proprietorship, you must attach a separate Schedule C for
each business. You can use the simpler Schedule C-EZ if you operated only one business as a sole proprietorship, you did not have a net loss, and you
meet the other requirements listed in Part I of the schedule.
I.R.S. e-file logoSummary: This is an illustration of the logo used to identify the I.R.S. e-file program.
You may be able to file your tax returns electronically using an IRS e-file option. Table 1-1 lists the benefits of IRS
e-file. IRS e-file uses automation to replace most of the manual steps needed to process paper returns. As a result, the
processing of e-file returns is faster and more accurate than the processing of paper returns. As with a paper return, you are responsible
for making sure your return contains accurate information and is filed on time.
Using e-file does not affect your chances of an IRS examination of your return.
You can file most commonly used business forms using IRS e-file. For more information, visit the IRS website at
www.irs.gov.
Electronic signatures.
Paperless filing is easier than you think and it's available to most taxpayers who file electronically—including those first-time filers who
were 16 or older at the end of 2005. If you file electronically using tax preparation software or a tax professional, you may be able to participate
in the Self-Select PIN (personal identification number) program. If you are married filing jointly, you and your spouse will each need to create a PIN
and enter these PINs as your electronic signatures.
To create a PIN, you must know your adjusted gross income (AGI) from your originally filed 2004 income tax return (not from an amended return,
Form 1040X, or any math error notice from the IRS). You will also need to provide your date of birth (DOB). Make sure your DOB is accurate and matches
the information on record with the Social Security Administration before you e-file. To do this, check your annual Social Security
Statement.
If you use a Self-Select PIN, there is nothing to sign and nothing to mail—not even your Forms W-2. For more details on the Self-Select PIN
program, visit the IRS website at
www.irs.gov.
Forms 8453 and 8453-OL.
Your return is not complete without your signature. If you are not eligible or choose not to sign your return electronically, you must complete,
sign, and file Form 8453, U.S. Individual Income Tax Declaration for an IRS e-file Return, or Form 8453-OL, U.S. Individual Income Tax
Declaration for an IRS e-file Online Return, whichever applies.
State returns.
In most states, you can file an electronic state return simultaneously with your federal return. For more information, check with your local IRS
office, state tax agency, tax professional, or the IRS website at
www.irs.gov.
Refunds.
You can have your refund check mailed to you, or you can have your refund deposited directly to your checking or savings account.
With e-file, your refund will be issued in half the time as when filing on paper. Most refunds are issued within 3 weeks. If you choose
Direct Deposit, you can receive your refund in as few as 10 days.
Offset against debts.Refund, offset against debtsTax refund:Offset against debtsDebtRefund offset against
As with a paper return, you may not get all of your refund if you owe certain past-due amounts, such as federal tax, state tax, a student loan, or
child support. You will be notified if the refund you claimed has been offset against your debts.
Refund inquiries.
You can check the status of your refund if it has been at least 3 weeks from the date you filed your return. Be sure to have a copy of your tax
return available because you will need to know the filing status, the first social security number shown on the return, and the exact whole-dollar
amount of the refund. To check on your refund, do one of the following.
Go to
www.irs.gov, and click on Where's My Refund.
Call 1-800-829-4477 for automated refund information, and follow the recorded instructions.
Call 1-800-829-1954 during the hours shown in your form instructions.
Balance due.Form:1040-V
If you owe tax, you must pay it by April 17, 2006, to avoid late-payment penalties and interest. You can make your payment electronically by
scheduling an electronic funds withdrawal from your checking or savings account or by credit card.
Using an Authorized IRS e-file Provider
Many tax professionals can electronically file paperless returns for their clients. You have two options.
You can prepare your return, take it to an authorized IRS e-file provider, and have the provider transmit it electronically to
the IRS.
You can have an authorized IRS e-file provider prepare your return and transmit it for you electronically.
You will be asked to complete Form 8879 to authorize the provider to enter your self-selected PIN on your return.
Depending on the provider and the specific services requested, a fee may be charged. To find an authorized IRS e-file provider near you,
go to
www.irs.gov or look for an Authorized IRS e-file Provider sign.
Using Your Personal Computer
A computer with a modem or Internet access is all you need to file your tax return using IRS e-file. Best of all, when you use your
personal computer, you can e-file your return from the comfort of your home any time of the day or night. Sign your return electronically
using a self-selected PIN to complete the process. There is no signature form to submit or Forms W-2 to send in.
Free Internet filing options.
More taxpayers can now prepare and e-file their individual income tax returns free using commercial tax preparation software accessible
through
www.irs.gov or
www.firstgov.gov. The IRS is partnering with the tax software industry to offer free preparation and filing
services to a significant number of taxpayers. Security and privacy certificate programs will assure tax data is safe and secure. To see if you
qualify for these services, visit the Free Internet Filing Homepage at
www.irs.gov.
If you cannot use the free services, you can buy tax preparation software at various electronics stores or computer and office supply stores. You
can also download software from the Internet or prepare and file your return completely online by using a tax preparation software package available
on the Internet.
Through Employers and Financial Institutions
Some businesses offer free e-file to their employees, members, or customers. Others offer it for a fee. Ask your employer or financial
institution if they offer IRS e-file as an employee, member, or customer benefit.
Free Help With Your Return
Free help in preparing your return is available nationwide from IRS-trained volunteers. The Volunteer Income Tax Assistance (VITA) program is
designed to help low-income taxpayers and the Tax Counseling for the Elderly (TCE) program is designed to assist taxpayers age 60 or older with their
tax returns. Some locations offer free electronic filing.
<ROM>Table 1-1.</ROM> Benefits of IRS <BIT>e-file</BIT>Accuracy•Your chance of getting an error notice from the IRS is significantly reduced.Security•Your privacy and security are assured.Electronic signatures•Create your own personal identification number (PIN) and file a completely paperless return through your tax preparation
software or tax professional. There is nothing to mail!Proof of acceptance•You receive an electronic acknowledgement within 48 hours that the IRS has accepted your return for processing.Fast refunds•You get your refund in half the time, even faster with Direct Deposit—in as few as 10 days.Free Internet filing options•Use the IRS website
www.irs.gov to access commercial tax preparation and e-file services available at no cost to eligible
taxpayers.Electronic payment options•Convenient, safe and secure electronic payment options are available. E-file and pay your taxes in a single step.
Schedule an electronic funds withdrawal from your checking or savings account (up to and including April 17, 2006) or pay by credit
card.Federal/State filing•Prepare and file your federal and state tax returns together and double the benefits you get from
e-file.
When Is My Tax Return Due?
Form 1040 for calendar year 2005 is due by April 17, 2006. If you use a fiscal year (explained in chapter 2), your return is due by the 15th day of
the 4th month after the end of your fiscal year. If you file late, you may have to pay penalties and interest. If you cannot file your return on time,
use Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return, to request an automatic 6-month
extension.
Form:4868
How Do I Pay Income Tax?Paying:Income taxEstimated taxIncome tax:How to payForm:1040-ES
Federal income tax is a pay-as-you-go tax. You must pay it as you earn or receive income during the year. An employee usually has income tax
withheld from his or her pay. If you do not pay your tax through withholding, or do not pay enough tax that way, you might have to pay estimated tax.
You generally have to make estimated tax payments if you expect to owe taxes, including self-employment tax (discussed later), of $1,000 or more when
you file your return. Use Form 1040-ES to figure and pay the tax. If you do not have to make estimated tax payments, you can pay any tax
due when you file your return. For more information on estimated tax, see Publication 505.
What are my payment options?
You can pay your estimated tax electronically using various options. If you pay electronically, there is no need to mail in Form 1040-ES payment
vouchers. These options include:
Paying electronically through the Electronic Federal Tax Payment System (EFTPS).
Paying by authorizing an electronic funds withdrawal when you file Form 1040 electronically.
Paying by credit card over the phone or by Internet.
Other options include crediting an overpayment from your 2005 return to your 2006 estimated tax, and mailing a check or money order with a Form
1040-ES payment voucher.
EFTPSEFTPS
To enroll in EFTPS, go to
www.eftps.gov or call 1-800-555-4477.
When you request a new EIN and you will have a tax obligation, you are automatically enrolled in EFTPS.
Benefits of EFTPS:
The chance of an error in making your payments is reduced.
You receive immediate confirmation of every transaction.
Penalty for underpayment of tax.Underpayment of tax penaltyPenalty:Underpayment of taxIncome tax:Underpayment penalty
If you did not pay enough income tax and self-employment tax for 2005 by withholding or by making estimated tax payments, you may have to pay a
penalty on the amount not paid. The IRS will figure the penalty for you and send you a bill. Or you can use Form 2210, Underpayment of
Estimated Tax by Individuals, Estates, and Trusts, to see if you have to pay a penalty and to figure the penalty amount. For more information, see
Publication 505.
Form:2210
Self-employment tax (SE tax) is a social security and Medicare tax primarily for individuals who work for themselves. It is similar to the social
security and Medicare taxes withheld from the pay of most wage earners.
If you earned income as a statutory employee, you do not pay SE tax on that income.
Social security coverage.Social security coverage
Social security benefits are available to self-employed persons just as they are to wage earners. Your payments of SE tax contribute to your
coverage under the social security system. Social security coverage provides you with retirement benefits, disability benefits, survivor benefits, and
hospital insurance (Medicare) benefits.
By not reporting all of your self-employment income, you could cause your social security benefits to be lower when you retire.
How to become insured under social security.
You must be insured under the social security system before you begin receiving social security benefits. You are insured if you have the required
number of credits (also called quarters of coverage), discussed next.
Earning credits in 2005 and 2006.
For 2005, you received one credit, up to a maximum of four credits, for each $920 ($970 for 2006) of income subject to social security taxes.
Therefore, for 2005, if you had income (self-employment and wages) of $3,680 that was subject to social security taxes, you received four credits
($3,680 ÷ $920).
For an explanation of the number of credits you must have to be insured and the benefits available to you and your family under the social security
program, consult your nearest Social Security Administration (SSA) office.
Making false statements to get or to increase social security benefits may subject you to penalties.
The Social Security Administration (SSA) time limit for posting self-employment income.Self-employment tax:SE taxSE tax:Time limit for posting income
Generally, the SSA will give you credit only for self-employment income reported on a tax return filed within 3 years, 3 months, and 15 days after
the tax year you earned the income. If you file your tax return or report a change in your self-employment income after this time limit, the SSA may
change its records, but only to remove or reduce the amount. The SSA will not change its records to increase your self-employment income.
Who must pay self-employment tax.
You must pay SE tax and file Schedule SE (Form 1040) if either of the following applies.
Your net earnings from self-employment (excluding church employee income) were $400 or more.
You had church employee income of $108.28 or more.
The SE tax rules apply no matter how old you are and even if you are already receiving social security or Medicare benefits.
SE tax rate.SE tax:Tax rate
The SE tax rate on net earnings is 15.3% (12.4% social security tax plus 2.9% Medicare tax).
Maximum earnings subject to SE tax.
Only the first $90,000 of your combined wages, tips, and net earnings in 2005 is subject to any combination of the 12.4% social security part of SE
tax, social security tax, or railroad retirement (tier 1) tax.
All your combined wages, tips, and net earnings in 2005 are subject to any combination of the 2.9% Medicare part of SE tax, social security tax, or
railroad retirement (tier 1) tax.
If your wages and tips are subject to either social security or railroad retirement (tier 1) tax, or both, and total at least $90,000, do not pay
the 12.4% social security part of the SE tax on any of your net earnings. However, you must pay the 2.9% Medicare part of the SE tax on all your net
earnings.
Deduct one-half of your SE tax as an adjustment to income on line 27 of Form 1040.
More information.
For information on methods of calculating SE tax, see Chapter 10, Self-Employment Tax.
<ROM>Table 1-2.</ROM> Which Forms Must I File?IF you are liable for:THEN use Form:DUE by:1Income tax1040 and Schedule C or C-EZ
215th day of 4th month after end of
tax year.Self-employment taxSchedule SEFile with Form 1040.Estimated tax1040-ES15th day of 4th, 6th, and 9th months of tax year, and 15th day of 1st month after the end of tax year.Social security and Medicare taxes and income tax withholding941April 30, July 31, October 31, and January 31
4.8109 (to make deposits)
3See Publication 15.Providing information on social security and Medicare taxes and income tax withholdingW-2 (to employee)
W-2 and W-3 (to the Social Security Administration)January 31
4.
Last day of February (March 31 if filing electronically)
4.Federal unemployment (FUTA) tax940 or 940-EZJanuary 31
4.8109 (to make deposits)
3April 30, July 31, October 31, and January 31, but only if the liability for unpaid tax is more than $500.Filing information returns for payments to nonemployees and transactions with other personsSee Information ReturnsForms 1099–to the recipient by January 31 and to the IRS by February 28 (March 31 if filing electronically).Other forms—See the General Instructions for Forms 1099, 1098, 5498, and W-2G.Excise taxSee Excise TaxesSee the instructions to the forms.
1 If a due date falls on a Saturday, Sunday, or legal holiday, the due date is the next business day. For more information, see Publication
509, Tax Calendars for 2006.2 File a separate schedule for each business.3 Do not use if you deposit taxes electronically.4 See the form instructions if you go out of business, change the form of your business, or stop paying
wages.
If you have employees, you will need to file forms to report employment taxes. Employment taxes include the following items.
Social security and Medicare taxes.
Federal income tax withholding.
Federal unemployment (FUTA) tax.
For more information, see Publication 15 (Circular E), Employer's Tax Guide. That publication explains your tax responsibilities as an
employer.
To help you determine whether the people working for you are your employees, see Publication 15-A, Employer's Supplemental Tax Guide. That
publication has information to help you determine whether an individual is an independent contractor or an employee.
If you incorrectly classify an employee as an independent contractor, you may be held liable for employment taxes for that worker plus a penalty.
An independent contractor is someone who is self-employed. You do not generally have to withhold or pay any taxes on payments to an independent
contractor.
Independent contractor
Excise TaxesExcise taxes:AboutTaxes:Excise
This section identifies some of the excise taxes you may have to pay and the forms you have to file if you do any of the following.
Manufacture or sell certain products.
Operate certain kinds of businesses.
Use various kinds of equipment, facilities, or products.
Receive payment for certain services.
For more information on excise taxes, see Publication 510, Excise Taxes for 2006.
Form 720.Form:720
The federal excise taxes reported on Form 720, Quarterly Federal Excise Tax Return, consist of several broad categories of taxes, including the
following.
Environmental taxes on the sale or use of ozone-depleting chemicals and imported products containing or manufactured with these
chemicals.
Communications and air transportation taxes.
Fuel taxes.
Tax on the first retail sale of heavy trucks, trailers, and tractors.
Manufacturers taxes on the sale or use of a variety of different articles.
Form 2290.Form:2290
There is a federal excise tax on the use of certain trucks, truck tractors, and buses on public highways. The tax applies to vehicles having a
taxable gross weight of 55,000 pounds or more. Report the tax on Form 2290, Heavy Highway Vehicle Use Tax Return. For more information, see the
instructions for Form 2290.
Depositing excise taxes.
If you have to file a quarterly excise tax return on Form 720, you may have to deposit your excise taxes before the return is due. For details on
depositing excise taxes, see the instructions for Form 720.
Information ReturnsInformation returns
If you make or receive payments in your business, you may have to report them to the IRS on information returns. The IRS compares the payments
shown on the information returns with each person's income tax return to see if the payments were included in income. You must give a copy of each
information return you are required to file to the recipient or payer. In addition to the forms described below, you may have to use other returns to
report certain kinds of payments or transactions. For more details on information returns and when you have to file them, see the General Instructions
for Forms 1099, 1098, 5498, and W-2G.
Form 1099-MISC.Form:1099-MISC
Use Form 1099-MISC, Miscellaneous Income, to report certain payments you make in your business. These payments include the following items.
Payments of $600 or more for services performed for your business by people not treated as your employees, such as fees to subcontractors,
attorneys, accountants, or directors.
Rent payments of $600 or more, other than rents paid to real estate agents.
Prizes and awards of $600 or more that are not for services, such as winnings on TV or radio shows.
Royalty payments of $10 or more.
Payments to certain crew members by operators of fishing boats.
You also use Form 1099-MISC to report your sales of $5,000 or more of consumer goods to a person for resale anywhere other than in a permanent
retail establishment.
Form W-2.Form:W-2
You must file Form W-2, Wage and Tax Statement, to report payments to your employees, such as wages, tips, and other compensation, withheld income,
social security, and Medicare taxes, and advance earned income credit payments. For more information on what to report on Form W-2, see the
Instructions for Forms W-2 and W-3.
Penalties.
The law provides for the following penalties if you do not file Form 1099-MISC or Form W-2 or do not correctly report the information. For more
information, see the General Instructions for Forms 1099, 1098, 5498, and W-2G.
Failure to file information returns. This penalty applies if you do not file information returns by the due date, do not include all
required information, or report incorrect information.
Penalty:Failure to file information returns
Failure to furnish correct payee statements. This penalty applies if you do not furnish a required statement to a payee by the required
date, do not include all required information, or report incorrect information.
Penalty:Failure to furnish correct payee statements
Waiver of penalties.
These penalties will not apply if you can show that the failure was due to reasonable cause and not willful neglect.
In addition, there is no penalty for failure to include all required information, or for including incorrect information, on a de minimis
(small) number of information returns if you correct the errors by August 1 of the year the returns are due. (A de minimis number of
returns is the greater of 10 or of 1% of the total number of returns you are required to file for the year.)
Form 8300.Form:8300
You must file Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business, if you receive more than $10,000 in cash in one
transaction, or two or more related business transactions. Cash includes U.S. and foreign coin and currency. It also includes certain monetary
instruments such as cashier's and traveler's checks and money orders. Cash does not include a check drawn on an individual's personal account
(personal check). For more information, see Publication 1544, Reporting Cash Payments of Over $10,000 (Received in a Trade or Business).
Penalties.
There are civil and criminal penalties, including up to 5 years in prison, for not filing Form 8300, filing (or causing the filing of) a false or
fraudulent Form 8300, or structuring a transaction to evade reporting requirements.
<ROM>Table 1-3.</ROM>
<IMARK> Going Out of Business Checklists(Note.The following checklists highlight the typical final forms and schedules you may need to file if you ever go out of
business. For more information, see the instructions for the listed forms.)IF you are liable for:THEN you may need to:Income tax□File Schedule C or C-EZ with your Form 1040 for the year in which you go out of business.□File Form 4797 with your Form 1040 for each year in which you sell or exchange property used in your business or in which the
business use of certain section 179 or listed property drops to 50% or less.□File Form 8594 with your Form 1040 if you sold your business.Self-employment tax□File Schedule SE with your Form 1040 for the year in which you go out of business.Employment taxes□File Form 941 for the calendar quarter in which you make final wage payments. Note. Do not forget to check the box
and enter the date final wages were paid on line 16.□File Form 940 or 940-EZ for the calendar year in which final wages were paid. Note. Do not forget to check the
box, If you will not have to file returns in the future..., under Question D.Information returns□Provide Forms W-2 to your employees for the calendar year in which you make final wage payments. Note. These forms
are generally due by the due date of your final Form 941.□File Form W-3 to file Forms W-2. Note. These forms are generally due within 1 month after the due date of your final
Form 941.□Provide Forms 1099-MISC to each person to whom you have paid at least $600 for services (including parts and materials) during
the calendar year in which you go out of business.□ File Form 1096 to file Forms 1099-MISC.
Accounting Periods and Methods
You must figure your taxable income and file an income tax return for an annual accounting period called a tax year. Also, you must consistently
use an accounting method that clearly shows your income and expenses for the tax year.
Publication538Accounting Periods and Methods
See chapter 12 for information about getting publications and forms.
Accounting PeriodsAccounting periodsDefinitions:Accounting periodsTax year
When preparing a statement of income and expenses (generally your income tax return), you must use your books and records for a specific interval
of time called an accounting period. The annual accounting period for your income tax return is called a
Tax yeartax year. You can use one of the following tax years.
A calendar tax year.
A fiscal tax year.
Unless you have a required tax year, you adopt a tax year by filing your first income tax return using that tax year. A required tax year is a
tax year required under the Internal Revenue Code or the Income Tax Regulations.
Calendar tax year.Calendar tax year defined
A calendar tax year is 12 consecutive months beginning January 1 and ending December 31.
You must adopt the calendar tax year if any of the following apply.
You keep no books.
You have no annual accounting period.
Your present tax year does not qualify as a fiscal year.
Your use of the calendar tax year is required under the Internal Revenue Code or the Income Tax Regulations.
If you filed your first income tax return using the calendar tax year and you later begin business as a sole proprietor, you must continue to use
the calendar tax year unless you get IRS approval to change it or are otherwise allowed to change it without IRS approval. For more information, see
Change in tax year, later.
If you adopt the calendar tax year, you must maintain your books and records and report your income and expenses for the period from January 1
through December 31 of each year.
Fiscal tax year.Fiscal tax year defined
A fiscal tax year is 12 consecutive months ending on the last day of any month except December. A 52-53-week tax year is a fiscal tax year that
varies from 52 to 53 weeks but does not have to end on the last day of a month.
If you adopt a fiscal tax year, you must maintain your books and records and report your income and expenses using the same tax year.
For more information on a fiscal tax year, including a 52-53-week tax year, see Publication 538.
Change in tax year.
Generally, you must file Form 1128, Application To Adopt, Change, or Retain a Tax Year, to request IRS approval to change your tax year. See the
instructions for Form 1128 for exceptions. If you qualify for an automatic approval request, a user fee is not required. If you do not qualify for
automatic approval, a ruling must be requested. See the instructions for Form 1128 for information about user fees if you are requesting a
ruling.
Form:1128
Accounting MethodsDefinitions:Accounting methods
An accounting method is a set of rules used to determine when and how income and expenses are reported. Your accounting method includes not only
the overall method of accounting you use, but also the accounting treatment you use for any material item.
You choose an accounting method for your business when you file your first income tax return that includes a Schedule C for the business. After
that, if you want to change your accounting method, you must generally get IRS approval. See Change in Accounting Method, later.
Kinds of methods.
Generally, you can use any of the following accounting methods.
Cash method.
An accrual method.
Special methods of accounting for certain items of income and expenses.
Combination method using elements of two or more of the above.
You must use the same accounting method to figure your taxable income and to keep your books. Also, you must use an accounting method that clearly
shows your income.
Business and personal items.
You can account for business and personal items under different accounting methods. For example, you can figure your business income under an
accrual method, even if you use the cash method to figure personal items.
Two or more businesses.
If you have two or more separate and distinct businesses, you can use a different accounting method for each if the method clearly reflects the
income of each business. They are separate and distinct only if you maintain complete and separate books and records for each business.
Cash MethodAccounting methodCashCash method of accounting
Most individuals and many sole proprietors with no inventory use the cash method because they find it easier to keep cash method records. However,
if an inventory is necessary to account for your income, you must generally use an accrual method of accounting for sales and purchases. For more
information, see Inventories, later.
IncomeCash method of accountingIncome
Under the cash method, include in your gross income all items of income you actually or constructively receive during your tax year. If you receive
property or services, you must include their fair market value in income.
Example.
On December 30, 2004, Mrs. Sycamore sent you a check for interior decorating services you provided to her. You received the check on January 2,
2005. You must include the amount of the check in income for 2005.
Constructive receipt.
You have constructive receipt of income when an amount is credited to your account or made available to you without restriction. You do not need to
have possession of it. If you authorize someone to be your agent and receive income for you, you are treated as having received it when your agent
received it.
Example.
Interest is credited to your bank account in December 2005. You do not withdraw it or enter it into your passbook until 2006. You must include it
in your gross income for 2005.
Delaying receipt of income.
You cannot hold checks or postpone taking possession of similar property from one tax year to another to avoid paying tax on the income. You must
report the income in the year the property is received or made available to you without restriction.
Example.
Frances Jones, a service contractor, was entitled to receive a $10,000 payment on a contract in December 2005. She was told in December that her
payment was available. At her request, she was not paid until January 2006. She must include this payment in her 2005 income because it was
constructively received in 2005.
Checks.
Receipt of a valid check by the end of the tax year is constructive receipt of income in that year, even if you cannot cash or deposit the check
until the following year.
Example.
Dr. Redd received a check for $500 on December 31, 2005, from a patient. She could not deposit the check in her business account until January 3,
2006. She must include this fee in her income for 2005.
Debts paid by another person or canceled.
If your debts are paid by another person or are canceled by your creditors, you may have to report part or all of this debt relief as income. If
you receive income in this way, you constructively receive the income when the debt is canceled or paid. For more information, see Canceled Debt
under Kinds of Income in chapter 5.
Repayment of income.Repayment of income
If you include an amount in income and in a later year you have to repay all or part of it, you can usually deduct the repayment in the year in
which you make it. If the amount you repay is over $3,000, a special rule applies. For details about the special rule, see Publication 535, Business
Expenses, chapter 13, Repayments.
ExpensesCash method of accountingExpenses
Under the cash method, you generally deduct expenses in the tax year in which you actually pay them. This includes business expenses for which you
contest liability. However, you may not be able to deduct an expense paid in advance or you may be required to capitalize certain costs, as explained
later under Uniform Capitalization Rules.
Expenses paid in advance.
You can deduct an expense you pay in advance only in the year to which it applies.
Example.
You are a calendar year taxpayer and you pay $1,000 in 2005 for a business insurance policy effective for one year, beginning July 1. You can
deduct $500 in 2005 and $500 in 2006.
Accrual MethodAccounting methodAccrualAccrual method of accounting
Under an accrual method of accounting, you generally report income in the year earned and deduct or capitalize expenses in the year incurred. The
purpose of an accrual method of accounting is to match income and expenses in the correct year.
Income–General RuleAccrual method of accountingIncome — general rule
Under an accrual method, you generally include an amount in your gross income for the tax year in which all events that fix your right to receive
the income have occurred and you can determine the amount with reasonable accuracy.
Example.
You are a calendar year, accrual method taxpayer. You sold a computer on December 28, 2005. You billed the customer in the first week of January
2006, but you did not receive payment until February 2006. You must include the amount received for the computer in your 2005 income.
Income–Special RulesAccrual method of accountingIncome — special rules
The following are special rules that apply to advance payments, estimating income, and changing a payment schedule for services.
Estimated income.
If you include a reasonably estimated amount in gross income, and later determine the exact amount is different, take the difference into account
in the tax year in which you make the determination.
Change in payment schedule for services.
If you perform services for a basic rate specified in a contract, you must accrue the income at the basic rate, even if you agree to receive
payments at a lower rate until you complete the services and then receive the difference.
Advance payments for services.
Generally, you report an advance payment for services to be performed in a later tax year as income in the year you receive the payment. However,
if you receive an advance payment for services you agree to perform by the end of the next tax year, you can elect to postpone including the advance
payment in income until the next tax year. However, you cannot postpone including any payment beyond that tax year.
For more information, see Advance Payment for Services under Accrual Method in Publication 538. That publication also
explains special rules for reporting the following types of income.
Advance payments for service agreements.
Advance payments under guarantee or warranty contracts.
Prepaid interest.
Prepaid rent.
Advance payments for sales.
Special rules apply to including income from advance payments on agreements for future sales or other dispositions of goods you hold primarily for
sale to your customers in the ordinary course of your business. If the advance payments are for contracts involving both the sale and service of
goods, it may be necessary to treat them as two agreements. An agreement includes a gift certificate that can be redeemed for goods. Treat amounts
that are due and payable as amounts you received.
You generally include an advance payment in income for the tax year in which you receive it. However, you can use an alternative method. For
information about the alternative method, see Publication 538.
ExpensesAccrual method of accountingExpenses
Under an accrual method of accounting, you generally deduct or capitalize a business expense when both the following apply.
The all-events test has been met. The test has been met when:
All events have occurred that fix the fact of liability, and
The liability can be determined with reasonable accuracy.
Economic performance has occurred.
Economic performance.
You generally cannot deduct or capitalize a business expense until economic performance occurs. If your expense is for property or services
provided to you, or for your use of property, economic performance occurs as the property or services are provided or as the property is used. If your
expense is for property or services you provide to others, economic performance occurs as you provide the property or services. An exception allows
certain recurring items to be treated as incurred during a tax year even though economic performance has not occurred. For more information on
economic performance, see Economic Performance under Accrual Method in Publication 538.
Example.
You are a calendar year taxpayer and use an accrual method of accounting. You buy office supplies in December 2005. You receive the supplies and
the bill in December, but you pay the bill in January 2006. You can deduct the expense in 2005 because all events that fix the fact of liability have
occurred, the amount of the liability could be reasonably determined, and economic performance occurred in that year.
Your office supplies may qualify as a recurring expense. In that case, you can deduct them in 2005 even if the supplies are not delivered until
2006 (when economic performance occurs).
Keeping inventories.
When the production, purchase, or sale of merchandise is an income-producing factor in your business, you must generally take inventories into
account at the beginning and the end of your tax year. If you must account for an inventory, you must generally use an accrual method of accounting
for your purchases and sales. For more information, see Inventories, later.
Special rule for related persons.Accrual method of accountingRelated persons, special ruleRelated persons:Special rule
You cannot deduct business expenses and interest owed to a related person who uses the cash method of accounting until you make the payment and the
corresponding amount is includible in the related person's gross income. Determine the relationship, for this rule, as of the end of the tax year for
which the expense or interest would otherwise be deductible. If a deduction is not allowed under this rule, the rule will continue to apply even if
your relationship with the person ends before the expense or interest is includible in the gross income of that person.
Related persons include members of your immediate family, including only brothers and sisters (either whole or half), your spouse, ancestors, and
lineal descendants. For a list of other related persons, see Related Persons under Accrual Method in Publication 538.
Combination MethodAccounting methodCombinationCombination method of accounting
You can generally use any combination of cash, accrual, and special methods of accounting if the combination clearly shows your income and expenses
and you use it consistently. However, the following restrictions apply.
If an inventory is necessary to account for your income, you must generally use an accrual method for purchases and sales. (See, however,
Inventories, later.) You can use the cash method for all other items of income and expenses.
If you use the cash method for figuring your income, you must use the cash method for reporting your expenses.
If you use an accrual method for reporting your expenses, you must use an accrual method for figuring your income.
If you use a combination method that includes the cash method, treat that combination method as the cash method.
InventoriesInventories
Generally, if you produce, purchase or sell merchandise in your business, you must keep an inventory and use the accrual method for purchases and
sales of merchandise. However, the following taxpayers can use the cash method of accounting even if they produce, purchase, or sell merchandise.
These taxpayers can also account for inventoriable items as materials and supplies that are not incidental (discussed later).
A qualifying taxpayer under Revenue Procedure 2001-10 in Internal Revenue Bulletin 2001-2.
A qualifying small business taxpayer under Revenue Procedure 2002-28 in Internal Revenue Bulletin 2002-18.
Qualifying taxpayer.
You are a qualifying taxpayer if:
Your average annual gross receipts for each prior tax year ending on or after December 17, 1998, is $1 million or less. (Your average annual
gross receipts for a tax year is figured by adding the gross receipts for that tax year and the 2 preceding tax years and dividing by 3.)
Your business is not a tax shelter, as defined under section 448(d)(3) of the Internal Revenue Code.
Qualifying small business taxpayer.
You are a qualifying small business taxpayer if:
Your average annual gross receipts for each prior tax year ending on or after December 31, 2000, is more than $1 million but not more than
$10 million. (Your average annual gross receipts for a tax year is figured by adding the gross receipts for that tax year and the 2 preceding tax
years and dividing the total by 3.)
You are not prohibited from using the cash method under section 448 of the Internal Revenue Code.
Your principal business activity is an eligible business (described in Publication 538 and Revenue Procedure 2002-28).
Business not owned or not in existence for 3 years.
If you did not own your business for all of the 3-tax-year period used in figuring your average annual gross receipts, include the period of any
predecessor. If your business has not been in existence for the 3-tax-year period, base your average on the period it has existed including any short
tax years, annualizing the short tax year's gross receipts.
Materials and supplies that are not incidental.
If you account for inventoriable items as materials and supplies that are not incidental, you will deduct the cost of the items you would otherwise
include in inventory in the year you sell the items, or the year you pay for them, whichever is later. If you are a producer, you can use any
reasonable method to estimate the raw material in your work in process and finished goods on hand at the end of the year to determine the raw material
used to produce finished goods that were sold during the year.
Changing methods.Changing methods
If you are a qualifying taxpayer or small business taxpayer and want to change to the cash method or to account for inventoriable items as
non-incidental materials and supplies, you must file Form 3115, Application for Change in Accounting Method.
More information.
For more information about the qualifying taxpayer exception, see Revenue Procedure 2001-10 in Internal Revenue Bulletin 2001-2. For more
information about the qualifying small business taxpayer exception, see Revenue Procedure 2002-28 in Internal Revenue Bulletin 2002-18.
Items included in inventory.
If you are required to account for inventories, include the following items when accounting for your inventory.
Merchandise or stock in trade.
Raw materials.
Work in process.
Finished products.
Supplies that physically become a part of the item intended for sale.
Valuing inventory.
You must value your inventory at the beginning and end of each tax year to determine your cost of goods sold (Schedule C, line 42). To determine
the value of your inventory, you need a method for identifying the items in your inventory and a method for valuing these items.
Inventory valuation rules cannot be the same for all kinds of businesses. The method you use to value your inventory must conform to generally
accepted accounting principles for similar businesses and must clearly reflect income. Your inventory practices must be consistent from year to year.
More information.
For more information about inventories, see Publication 538.
Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for production or resale activities.
Include these costs in the basis of property you produce or acquire for resale, rather than claiming them as a current deduction. You recover the
costs through depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of the property.
Activities subject to the rules.
You may be subject to the uniform capitalization rules if you do any of the following, unless the property is produced for your use other than in a
business or an activity carried on for profit.
Produce real or tangible personal property. For this purpose, tangible personal property includes a film, sound recording, video tape, book,
or similar property.
Acquire property for resale.
Exceptions.
These rules do not apply to the following property.
Personal property you acquire for resale if your average annual gross receipts are $10 million or less.
Property you produce if you meet either of the following conditions.
Your indirect costs of producing the property are $200,000 or less.
You use the cash method of accounting and do not account for inventories. For more information, see Inventories, earlier.
Special MethodsAccounting methodSpecial
There are special methods of accounting for certain items of income or expense. These include the following.
Amortization, discussed in chapter 9 of Publication 535, Business Expenses.
Bad debts, discussed in chapter 11 of Publication 535.
Depletion, discussed in chapter 10 of Publication 535.
Depreciation, discussed in Publication 946, How To Depreciate Property.
Installment sales, discussed in Publication 537, Installment Sales.
Change in
Accounting MethodAccounting methodChange in
Once you have set up your accounting method, you must generally get IRS approval before you can change to another method. A change in your
accounting method includes a change in:
Your overall method, such as from cash to an accrual method, and
Your treatment of any material item.
To get approval, you must file Form 3115, Application for Change in Accounting Method. You can get IRS approval to change an
accounting method under either the automatic change procedures or the advance consent request procedures. You may have to pay a user fee. For more
information, see the form instructions.
Form:3115
Certain taxpayers can presume to have IRS approval to change their method of accounting. The approval is granted for the tax year for which the
taxpayer requests a change (year of change), if the taxpayer complies with the provisions of the automatic change procedures. No user fee is required
for an application filed under an automatic change procedure generally covered in Revenue Procedure 2002-9.
Generally, you must use Form 3115 to request an automatic change. For more information, see the form instructions.
Dispositions of
Business Property
If you dispose of business property, you may have a gain or loss that you report on Form 1040. However, in some cases you may have a gain that is
not taxable or a loss that is not deductible. This chapter discusses whether you have a disposition, how to figure the gain or loss, and where to
report the gain or loss.
Sales of assetsDisposition of property:Business propertyPublication544Sales and Other Dispositions of AssetsForm (and Instructions)Sales of Business PropertyCapital Gains and Losses
See chapter 12 for information about getting publications and forms.
What Is a Disposition
of Property?Definitions:Dispositions of property
A disposition of property includes the following transactions.
You sell property for cash or other property.
You exchange property for other property.
You receive money as a tenant for the cancellation of a lease.
You receive money for granting the exclusive use of a copyright throughout its life in a particular medium.
You transfer property to satisfy a debt.
You abandon property.
Your bank or other financial institution forecloses on your mortgage or repossesses your property.
Your property is damaged, destroyed, or stolen, and you receive property or money in payment.
Your property is condemned, or disposed of under the threat of condemnation, and you receive property or money in payment.
For details about damaged, destroyed, or stolen property, see Publication 547, Casualties, Disasters, and Thefts. For details about other
dispositions, see chapter 1 in Publication 544.
Nontaxable exchanges.Disposition of property:Nontaxable exchangeNontaxable exchanges
Certain exchanges of property are not taxable. This means any gain from the exchange is not recognized and you cannot deduct any loss. Your gain or
loss will not be recognized until you sell or otherwise dispose of the property you receive.
Like-kind exchanges.Disposition of property:Like-kind exchangeLike-kind exchanges
A like-kind exchange is the exchange of property for the same kind of property. It is the most common type of nontaxable exchange. To be a
like-kind exchange, the property traded and the property received must be both of the following.
Business or investment property.
Like property.
Report the exchange of like-kind property on Form 8824, Like-Kind Exchanges. For more information about like-kind exchanges, see chapter
1 in Publication 544.
Form:8824
Installment sales.Disposition of property:Installment saleInstallment sales
An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. If you finance the buyer's
purchase of your property, instead of having the buyer get a loan or mortgage from a third party, you probably have an installment sale.
For more information about installment sales, see Publication 537, Installment Sales.
Sale of a business.Disposition of property:Sale of a businessSale of a business
The sale of a business usually is not a sale of one asset. Instead, all the assets of the business are sold. Generally, when this occurs, each
asset is treated as being sold separately for determining the treatment of gain or loss.
Both the buyer and seller involved in the sale of a business must report to the IRS the allocation of the sales price among the business assets.
Use Form 8594, Asset Acquisition Statement Under Section 1060, to provide this information. The buyer and seller should each attach Form
8594 to their federal income tax return for the year in which the sale occurred.
Form:8594
For more information about the sale of a business, see chapter 2 of Publication 544.
How Do I Figure
a Gain or Loss?
<ROM>Table 3-1.</ROM> How To Figure a Gain or LossIF your...THEN you have a...Adjusted basis is more than the amount realizedLoss.Amount realized is more than the adjusted basisGain.
Basis, adjusted basis, amount realized, fair market value, and amount recognized are defined next. You need to know these definitions to figure
your gain or loss.
Basis.Basis of propertyDefinitions:Basis
The cost or purchase price of property is usually its basis for figuring the gain or loss from its sale or other disposition. However, if you
acquired the property by gift, inheritance, or in some way other than buying it, you must use a basis other than its cost. For more information about
basis, see Publication 551, Basis of Assets.
Adjusted basis.Adjusted basis of property
The adjusted basis of property is your original cost or other basis plus certain additions, and minus certain deductions such as depreciation and
casualty losses. In determining gain or loss, the costs of transferring property to a new owner, such as selling expenses, are added to the adjusted
basis of the property.
Amount realized.
The amount you realize from a disposition is the total of all money you receive plus the fair market value of all property or services you receive.
The amount you realize also includes any of your liabilities that were assumed by the buyer and any liabilities to which the property you transferred
is subject, such as real estate taxes or a mortgage.
Fair market value.Definitions:Fair market valueFair market value
Fair market value is the price at which the property would change hands between a buyer and a seller, neither having to buy or sell, and both
having reasonable knowledge of all necessary facts.
Amount recognized.
Your gain or loss realized from a disposition of property is usually a recognized gain or loss for tax purposes. Recognized gains must be included
in gross income. Recognized losses are deductible from gross income. However, a gain or loss realized from certain exchanges of property is not
recognized. See Nontaxable exchanges, earlier. Also, you cannot deduct a loss from the disposition of property held for personal use.
Is My Gain or Loss
Ordinary or Capital?Capital gain or lossOrdinary gain or loss
You must classify your gains and losses as either ordinary or capital gains or losses. You must do this to figure your net capital gain or loss.
Generally, you will have a capital gain or loss if you dispose of a capital asset. For the most part, everything you own and use for personal purposes
or investment is a capital asset.
Certain property you use in your business is not a capital asset. A gain or loss from a disposition of this property is an ordinary gain or loss.
However, if you held the property longer than 1 year, you may be able to treat the gain or loss as a capital gain or loss. These gains and losses are
called section 1231 gains and losses.
For more information about ordinary and capital gains and losses, see chapters 2 and 3 in Publication 544.
Is My Capital Gain or Loss
Short Term or Long Term?Long-term capital gain or lossShort-term capital gain or loss
If you have a capital gain or loss, you must determine whether it is long term or short term. Whether a gain or loss is long or short term depends
on how long you own the property before you dispose of it. The time you own property before disposing of it is called the holding period.
<ROM>Table 3-2.</ROM>
<IMARK>Do I Have a Short-Term or Long-Term Gain or Loss?IF you hold the property...THEN you have a...1 year or lessShort-term capital gain or loss.More than 1 yearLong-term capital gain or loss.
For more information about short-term and long-term capital gains and losses, see chapter 4 of Publication 544.
Where Do I Report
Gains and Losses?
Report gains and losses from the following dispositions on the forms indicated. The instructions for the forms explain how to fill them out.
Dispositions of business property and depreciable property.
Use Form 4797. If you have taxable gain, you may also have to use Schedule D (Form 1040).
Form:4797
Like-kind exchanges.Disposition of property:Like-kind exchange
Use Form 8824, Like-Kind Exchanges. You may also have to use Form 4797 and Schedule D (Form 1040).
Form:8824
Installment sales.Disposition of property:Installment sale
Use Form 6252, Installment Sale Income. You may also have to use Form 4797 and Schedule D (Form 1040).
Form:6252
Casualties and thefts.
Use Form 4684, Casualties and Thefts. You may also have to use Form 4797.
Form:4684
Condemned property.Condemned property
Use Form 4797. You may also have to use Schedule D (Form 1040).
Form:4797
General Business CreditsBusiness creditsCredits:Business
Your general business credit for the year consists of your carryforward of business credits from prior years plus the total of your current year
business credits. In addition, your general business credit for the current year may be increased later by the carryback of business credits from
later years. You subtract this credit directly from your tax.
Publication954Tax Incentives for Distressed CommunitiesForm (and Instructions)General Business CreditAlternative Minimum Tax—Individuals
See chapter 12 for information about getting publications and forms.
Business CreditsGeneral business credits
All of the following credits are part of the general business credit. The form you use to figure each credit is shown in parentheses. Be sure you
also read How To Claim the Credit, later, because you may also have to fill out Form 3800 in certain situations.
This credit applies to the cost of any qualified fuel vehicle refueling property placed in service after December 31, 2005, for tax years ending
after that date. For more information, see Form 8911.
Alternative motor vehicle credit (Form 8910).Alternative motor vehicle creditCredit:Alternative motor vehicleMotor vehicle, alternative creditForm:8910
This credit consists of the following four credits for new vehicles placed in service after December 31, 2005, for tax years ending after that
date. For more information, see Form 8910.
Qualified fuel cell motor vehicle credit.Credit:Qualified fuel cell motor vehicle credit
Advanced lean burn technology motor vehicle credit. Credit:Advanced lean burn technology motor vehicle credit
Qualified hybrid motor vehicle credit. Credit:Qualified hybrid motor vehicle credit
Qualified alternative fuel motor vehicle credit. Credit:Qualified alternative fuel motor vehicle credit
Biodiesel and renewable diesel fuels credit (Form 8864)Biodiesel and renewable diesel fuels creditCredit:Biodiesel fuelsDiesel fuels, renewableForm:8864
This credit applies to certain fuel sold or used in your business. For more information, see Form 8864.
Credit for alcohol used as a fuel (Form 6478).
This credit applies to alcohol sold or used as a fuel. Alcohol, for purposes of this credit, includes ethanol and methanol. It does not include
alcohol produced from petroleum, natural gas, coal, or peat. For more information, see Form 6478.
Credit for contributions to selected community development corporations (Form 8847).Contributions to selected community development corporations, credit forCredit:Contributions to selected community development corporationsForm:8847
This credit applies to certain contributions made to a selected community development corporation before June 30, 1999. For more information, see
Form 8847.
Credit for employee social security and Medicare taxes paid on certain employee tips (Form 8846).Taxes:Paid on certain employee tipsCredit:Taxes paid on certain employee tipsForm:8846
The credit is generally equal to your (employer's) portion of social security and Medicare taxes paid on tips received by employees of your food
and beverage establishment where tipping is customary. The credit applies regardless of whether the food is consumed on or off your business premises.
However, you cannot get credit for your part of social security and Medicare taxes on those tips that are used to meet the federal minimum wage rate
that applies to the employee under the Fair Labor Standards Act. For more information, see Form 8846.
Credit for employer-provided childcare facilities and services (Form 8882).
This credit applies to the qualified expenses you paid for employee childcare and qualified expenses you paid for childcare resource and referral
services. The credit is 25% of qualified expenses you paid for employee childcare and 10% of qualified expenses you paid for childcare resource and
referral services. This credit is limited to $150,000 each year. For more information, see Form 8882.
Credit for increasing research activities (Form 6765).Research creditCredit:ResearchForm:6765
The research credit is designed to encourage businesses to increase the amounts they spend on research and experimental activities, including
energy research. The credit is generally 20% of the amount by which your research expenses for the year are more than your base amount. For more
information, see Form 6765.
Credit for small employer pension startup costs (Form 8881).
This credit applies to pension plan startup costs. If you begin a new qualified defined benefit or defined contribution plan (including a 401(k)
plan), SIMPLE plan, or simplified employee pension, you can receive a tax credit of 50% of the first $1,000 of qualified startup costs. For more
information, see Publication 560, Retirement Plans for Small Business (SEP, Simple, and Qualified Plans).
The disabled access credit is a nonrefundable tax credit for an eligible small business that pays or incurs expenses to provide access to persons
who have disabilities. You must pay or incur the expenses to enable your business to comply with the Americans with Disabilities Act of 1990. For more
information, see Form 8826.
This credit is available to distillers and importers of distilled spirits and eligible wholesalers of distilled spirits for tax years beginning
after September 30, 2005. For more information, see Form 8906.
Empowerment zone and renewal community employment credit (Form 8844).Empowerment zone employment creditCredit:Empowerment zone employmentForm:8844
You may qualify for this credit if you have employees and are engaged in a business in an empowerment zone or renewal community for which the
credit is available. For more information, see Form 8844 and Publication 954.
Energy efficient appliance credit (Form 8909).Energy efficient appliance credit
This credit is available for each type of qualified energy efficient appliance produced by the taxpayer after December 31, 2005, in a tax year
ending on or after December 31, 2006. For more information, see Form 8909.
Energy efficient home credit (Form 8908).Energy efficient home credit
This credit is available for eligible contractors of certain homes sold for use as a residence after December 31, 2005. For more information, see
Form 8908.
This credit provides certain employers with an incentive to continue to pay certain wages after August 28, 2005, and before January 1, 2006. For
more information, see Form 5884-A.
Indian employment credit (Form 8845).Indian employment creditCredit:Indian employmentForm:8845
This credit applies to the part of the qualified wages and health insurance costs (up to $20,000 per employee) you paid or incurred during a tax
year that is more than the sum of the comparable costs you (or your predecessor) paid or incurred during calendar year 1993. The employee must be an
enrolled member, or the spouse of an enrolled member, of an Indian tribe. The employee must perform substantially all of his or her services within an
Indian reservation while living on or near the reservation. For more information, see Form 8845 and Publication 954.
For tax years ending after December 31, 2005, this credit will be treated as a general business credit. For more information, see Form 8907.
Orphan drug credit (Form 8820).Orphan drug creditCredit:Orphan drugForm:8820
The orphan drug credit applies to qualified expenses incurred in testing certain drugs, known as orphan drugs for rare diseases and
conditions. For more information, see Form 8820.
Certain regional and switching railroads may be able to claim a credit for expenses made to upgrade their railroad tracks (including roadbed,
bridges, and related track structures). For more information, see Form 8900.
Renewable electricity, refined coal, and Indian coal production credit (Form 8835).Renewable electricity, refined coal, and Indian coal production creditCredit:Renewable electricityRefined coalIndian coalForm:8835
For more information on the renewable electricity, refined coal, and Indian coal production credit, see Form 8835.
The welfare-to-work credit provides businesses with an incentive to hire long-term family assistance recipients. For more information, see Form
8861 and Publication 954.
Work opportunity credit (Form 5884).Work opportunity creditCredit:Work opportunityForm:5884
The work opportunity credit provides businesses with an incentive to hire individuals from targeted groups that have a particularly high
unemployment rate or other special employment needs. For more information, see Form 5884 and Publication 954.
How To Claim the CreditCredit:How to claim
To claim a general business credit, you will first have to get the forms you need to claim your current year business credits.
In addition to the credit form, you may also need to file Form 3800. See the next discussion to decide whether you need to file Form 3800.
Who must file Form 3800?Form:3800
You must file Form 3800 if any of the following apply.
You have more than one of the credits listed above (other than the credit for alcohol used as a fuel (Form 6478), the empowerment zone and
renewal community employment credit (Form 8844), or the renewable electricity, refined coal, and Indian coal production credit (Form 8835, Section
B)).
Any of these credits (other than the low-income housing credit) is from a passive activity. For information about passive activity credits,
see Form 8582-CR.
You have a carryback or carryforward of any of these credits.
The general business credit includes the credits listed under General Business Credits, the empowerment zone and renewal community
employment credit (Form 8844), the alcohol fuel credit (Form 6478), and the portion of the renewable electricity, refined coal, and Indian coal
production credit figured in Section B of Form 8835.
Forms 8844, 6478, and 8835 have special tax liability limits and are not reported on Form 3800. Any carryback, carryforward, and passive activity
limitation of these credits is computed separately on the forms on which they are claimed.
Alternative minimum tax (AMT).Alternative minimum tax
Although you may not owe AMT, you must still figure your tentative minimum tax on Form 6251 if you claim a general business credit. After you fill
in Form 6251, attach it to your tax return.
Form:6251
Business IncomeBusiness income
This chapter primarily explains business income and how to account for it on your tax return, what items are not considered income, and gives
guidelines for selected occupations.
If there is a connection between any income you receive and your business, the income is business income. A connection exists if it is clear that
the payment of income would not have been made if you did not have the business.
You can have business income even if you are not involved in the activity on a regular full-time basis. Income from work you do on the side in
addition to your regular job can be business income.
You report most business income, such as income from the sale of your products or services, on Schedule C or C-EZ. But you report the income from
the sale of business assets, such as land and office buildings, on other forms instead of Schedule C or C-EZ. For information on selling business
assets, see chapter 3.
Nonemployee compensation. Business income includes amounts you received in your business that were properly shown on Forms 1099-MISC.
This includes amounts reported as nonemployee compensation in box 7 of the form. You can find more information in the instructions on the back of the
Form 1099-MISC you received.
Nonemployee compensation
Kinds of Income
You must report on your tax return all income you receive from your business unless it is excluded by law. In most cases, your business income will
be in the form of cash, checks, and credit card charges. But business income can be in other forms, such as property or services. These and other
types of income are explained next.
If you are a U.S. citizen who has business income from sources outside the United States (foreign income), you must report that income on your tax
return unless it is exempt from tax under U.S. law. If you live outside the United States, you may be able to exclude part or all of your
foreign-source business income. For details, see Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.
Bartering for Property or ServicesIncome:BarterBarter incomeDefinitions:Bartering
Bartering is an exchange of property or services. You must include in your gross receipts, at the time received, the fair market value of property
or services you receive in bartering. If you exchange services with another person and you both have agreed ahead of time on the value of the
services, that value will be accepted as the fair market value unless the value can be shown to be otherwise.
Example 1.
You are a self-employed lawyer. You perform legal services for a client, a small corporation. In payment for your services, you receive shares of
stock in the corporation. You must include the fair market value of the shares in income.
Example 2.
You are an artist and create a work of art to compensate your landlord for the rent-free use of your apartment. You must include the fair rental
value of the apartment in your gross receipts. Your landlord must include the fair market value of the work of art in his or her rental income.
Example 3.
You are a self-employed accountant. Both you and a house painter are members of a barter club, an organization that each year gives its members a
directory of members and the services each member provides. Members get in touch with other members directly and bargain for the value of the services
to be performed.
In return for accounting services you provided for the house painter's business, the house painter painted your home. You must include in gross
receipts the fair market value of the services you received from the house painter. The house painter must include the fair market value of your
accounting services in his or her gross receipts.
Example 4.
You are a member of a barter club that uses credit units to credit or debit members' accounts for goods or services provided or received. As soon
as units are credited to your account, you can use them to buy goods or services or sell or transfer the units to other members.
You must include the value of credit units you received in your gross receipts for the tax year in which the units are credited to your account.
The dollar value of units received for services by an employee of the club, who can use the units in the same manner as other members, must be
included in the employee's gross income for the tax year in which received. It is wages subject to social security and Medicare taxes (FICA), federal
unemployment taxes (FUTA), and income tax withholding. See Publication 15 (Circular E), Employer's Tax Guide.
Example 5.
You operate a plumbing business and use the cash method of accounting. You join a barter club and agree to provide plumbing services to any member
for a specified number of hours. Each member has access to a directory that lists the members of the club and the services available.
Members contact each other directly and request services to be performed. You are not required to provide services unless requested by another
member, but you can use as many of the offered services as you wish without paying a fee.
You must include the fair market value of any services you receive from club members in your gross receipts when you receive them even if you have
not provided any services to club members.
Information returns.
If you are involved in a bartering transaction, you may have to file either of the following forms.
Form 1099-B, Proceeds From Broker and Barter Exchange Transactions.
Form:1099-B
Form 1099-MISC, Miscellaneous Income.
Form:1099-MISC
For information about these forms, see the General Instructions for Forms 1099, 1098, 5498, and W-2G.
