You are a sole proprietor if you own an unincorporated business including a limited liability company, by yourself. Report your income and expenses from your sole proprietorship on Schedule C Form 1040, "Profit or Loss From Business," or on Schedule C-EZ Form 1040, "Net Profit From Business."

You may use Schedule C-EZ to determine your net profit if you have only one sole proprietorship and you meet all the requirements listed in Part 1 of Schedule C-EZ. If you can use Schedule C-EZ, gross receipts and total expenses from your business are reported in Part II. The difference between gross receipts and total expenses you reported is your net profit. Report net profit on line 12 of your Form 1040 (PDF).

You cannot use Schedule C-EZ if your business expenses were more than $2,500, your business used the accrual method of accounting, you deducted expenses for the business use of your home, or if you had employees, a net loss, or inventory.

If you cannot use Schedule C-EZ, you must report your business income and expenses on Schedule C.

If you have more than one sole proprietorship business, or if you and your spouse have separate businesses, you must use a separate Schedule C for each business.

Report the income from your business in Part I of Schedule C and the expenses in Part II. If you make or buy goods to sell, use Part III to figure the cost of goods sold. The difference between total income and total expenses is your net profit or loss, which will be taken from Schedule C and entered on line 12 of your Form 1040.

Historically, a taxpayer has been required to use an accrual accounting method with regard to purchases and sales of merchandise whenever the taxpayer was required to account for inventories. Recently, in Revenue Procedure 2001-10, 2001-2 Internal Revenue Bulletin 272, the Commissioner has exempted some qualifying taxpayers from the need to use an accrual accounting method or to account for inventories.

Rev. Proc. 2001-10 is only available to be used by "qualifying taxpayers." A qualifying taxpayer is a taxpayer (1) who has average annual gross receipts of $1,000,000 or less and (2) who is not a tax shelter within the meaning of Internal Revenue Code Section 448(a)(3).

If you are a qualifying taxpayer, Rev. Proc. 2001-10 permits you to choose:

• Use the cash accounting method and treat your inventoriable items as inventory within the meaning of IRC § 471,
• Use the cash accounting method and treat your inventoriable items as materials and supplies that are not incidental within the meaning of Treas. Reg. § 1.162-3, or
• Use an accrual accounting method and treat your inventoriable items as materials and supplies that are not incidental within the meaning of Treas. Reg. § 1.162-3.

You can also follow the historic rule, that is, use an accrual accounting method and treat your inventoriable items as inventory within the meaning of IRC § 471.

Be aware that the Rev Proc. 2001-10 (i.e., cash accounting method or accrual accounting method) specifically states when you can deduct the costs for the inventoriable items that are being treated as materials and supplies. In the case of a cash method taxpayer, the cost for these items cannot be deducted until the year in which (1) you sell the items or (2) you pay for them, whichever is later.

Rev. Proc. 2001-10 provides detailed procedures for determining whether you satisfy the average annual gross receipts test. You should review carefully section 5 of Rev. Proc. 2001-10 for these procedures.

If you use part of your home in your business, you should complete Form 8829 (PDF). For more information, order Publication 587 (PDF), Business Use of Your Home (Including Use by Day-Care Providers), or refer to Tax Topic 509.

If the total of your net earnings from all businesses is $400 or more, you must compute your self-employment tax on Form 1040 Schedule SE (PDF). For more information, order Publication 533 (PDF), Self-Employment Tax, or refer to Tax Topic 554.

If you are new in business, you may want to refer to Publication 583 (PDF), Starting a Business and Keeping Records. Publication 334 (PDF), Tax Guide for Small Business, has more information on income and expenses from a sole proprietorship. Refer to Tax Topic 103, Small Business Tax Education Program.

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