The Self Employed Taxpayer

There are many husband and wife teams that own and operate a business together. If one of them is the primary owner, they may file a Schedule C to report their income and expenses. If they own the business together and share in the profit or losses, they generally must file a partnership return. However, there are two exceptions to this rule. The first is for taxpayers that own and operate their business in a community property state. They may treat the business as a sole proprietorship or a partnership. The second exception is a “Qualified Joint Venture”. If the taxpayer and spouse materially participate as the only owners of a jointly owned and operated business and they file a joint return, they may each divide the income and expenses in accordance with their respective interests. They will each file a separate Schedule C for their portion of the income and expenses. If the taxpayer has employees, they are required to report employment taxes. Most employers must withhold and pay income tax, social security tax, and Medicare tax. The taxpayer must also pay FUTA (federal unemployment tax). The taxpayer must also file a Form W-2 for each employee at the end of the tax year. Filing Requirement for the Self Employed If the taxpayer’s net earnings from self employment are $400 or more, they are required to file a return. If the taxpayer’s net earnings from self employment are less than $400 and they meet any of the other filing requirements, they will still be required to file a tax return. Schedule C If the taxpayer has self employment income, a Schedule C will need to be filed. If the taxpayer owns more than one business, a separate Schedule C must be filed for each business. Line A: The taxpayer’s business or professional activity that provided the main source of income reported on the Schedule C is reported here. Enter the general field or activity and the type of product or service. If the taxpayer is in wholesale or retail trade, or services connected with production services, also enter the type of customer or client the taxpayer targets. Line B: The principal business or professional activity code is entered on this line. Illustration 2 is a sample of the table. The table in its entirety can be found in the appendix. Select the category that best describes the principal business and enter the six digit code. For example, someone whose principal business is Drywall installation will enter 238310 as their six digit code. Line D: The taxpayer will need an employer ID number if they had a qualified retirement plan, or were required to file an employment, excise, estate, trust, or alcohol, tobacco, and firearms tax return. If the taxpayer has an EIN it will be entered here. If the taxpayer does not, leave this line blank. Do not enter the SSN on this line. Line E: Enter the address at which the business is located. If the business is located at the home address reported on the Form 1040, this line may be left blank. Line F: The accounting method the taxpayer used in their business must be specified here. Cash Method This is the most widely used method. The cash method of accounting requires the taxpayer to include income when it is actually or constructively received. The expenses are deducted when they are paid. Accrual Method The accrual method requires the taxpayer to include income when it is earned and to deduct expenses when they are incurred. If the taxpayer has inventory, they must generally use the accrual method for the sales and purchases. Hybrid Method The hybrid method is a combination of both accounting methods. It is especially used when the taxpayer has inventory and the taxpayer must use the accrual method of accounting for the inventory, but uses the cash method of accounting for everything else. Note: The taxpayer can use the cash method of accounting if they have inventory and they meet one of the following requirements: • The taxpayer had average gross receipts of less than $1 million over the previous three years. • The taxpayer does not qualify as a tax shelter. In this case, the inventory expense is treated as a current year tax deduction.