Most small businesses are set up to "pass through" income. If you're a sole proprietor or run an S corporation, your business doesn't pay taxes. Instead, the money passes through to you, and you report it as personal income. The first step in this process is to figure out your gross receipts from sales.
Add up your total sales to get gross receipts. If you've kept good records, it should be simple. Then subtract the cost of goods sold, as well as sales returns and allowances, to get your total income.
Your choice of accounting method is going to affect how you calculate your gross receipts. The IRS says there are two main methods for calculating self-employment income: cash and accrual. You can use other methods as long as they're IRS-approved and accurately reflect your income.
Advertisement Article continues below this adCash accounting is the simpler method because you only report income when you are paid. For example, suppose right before Christmas you sell $12,000 worth of wholesale goods to a retailer on credit. If the retailer settles its bill before the end of the year, that's $12,000 in added sales income. If the retailer doesn't pay the invoice until January, you count the money as next year's income.
With accrual accounting, you report sales when the transaction is done, even if you aren't paid immediately, Accounting Tools explains. A $12,000 December credit sale counts as December income even if the customer doesn't pay until February. This gives you a better feel for profits, but the accounting is more complicated. You have to track cash flows separately and include an allowance for bad debts.
There are some restrictions on your choice of method. Businesses making more than $5 million a year must use accrual accounting, for example. Whichever method you use, you have to employ it consistently and accurately. If you're using cash accounting, recognizing any credit sales is a mistake that throws your tax accounting off.
Advertisement Article continues below this adWhen you look at IRS Schedule C, the form for self-employment income, Part One's first line says to provide your gross receipts. This part is simple: The instructions say to write in your total sales revenue, whether it's from goods or services. If you've kept track of your sales, this part is easy; add up sale after sale until you get the total for the year.
If you've issued refunds or sales allowances for defective merchandise, you list the total on line two. Refunds are occurrences where you return the cash or credit price of the goods you sold; allowances are where you give the customer a partial markdown on the price because of a problem. Subtract refunds and allowances from gross receipts.
Next, you subtract the cost of goods sold (COGS), which you calculate on the back of Schedule C. You start with the cost of the beginning-year inventory and add in any subsequent inventory purchases and the labor, materials and supplies involved in making more inventory. Subtract the value of inventory at the end of the year to get COGS.
Advertisement Article continues below this adFor example, suppose your cellphone store starts the year with $85,000 in inventory. You spend another $24,000 to replenish your inventory over the course of the year, giving you $109,000 in inventory. At year's end you have $60,000 in inventory; subtracting that from the total gives you $49,000 as the cost of goods sold.
If you have income from sources other than your main line of business, you report that on line six of Schedule C. This could include interest, lease income or property sales. For example, if you're a manufacturer and you lease part of your factory to another company, that would go on line six. Combine all these items together to get your gross income, then subtract your expenses to see how much income is taxable.