 Income tax 2023-2024. Business income or loss and other gains or losses. Get ready and some coffee so we can avoid the government forcing us to move into a shack with income tax preparation 2023-2024. Most of this information can be found in the Instructions for Schedule 1 section of the Form 1040 Instructions Tax Year 2023, which you can find on the IRS website at irs.gov, irs.gov. Looking at the income tax formula, we're focused online on income. Remember in the first half of the income tax formula is basically a funny income statement where normally you have income minus expenses resulting in net income. Here we have income minus various deductions results in taxable income. The income line, we want it as low as possible for taxes, therefore looking for things that we can exclude from income, also noting that some types of income might have more favorable tax rates other than ordinary income tax rates such as, for example, qualified dividends, long-term capital gains, possibly. First page of the Form 1040 here, we're looking at line number 8, which has additional income from Schedule 1. Here's the Schedule 1 that feeds into that line 8, additional income and adjustments to income. We're looking now at line 3 of Part 1, business income or loss. This will typically flow in from another schedule, which will be a Schedule C. The Schedule C usually being, in essence, an income statement for the business. Okay, so we're looking reporting business income for sole proprietorship in the tax year 2023, which involves summarizing your business's revenue, expenses, and net profit or loss for the year. Now, we'll talk more about a sole proprietor type of business in future presentations. Right now, since we're looking at the income line items, we want to focus in and just show that this would be one item that could be included in income. We want to take the time now to note that if you're a tax preparer, then you might want to think about where you're specializing in your returns. Are you specializing in individual income tax returns, higher income tax returns, lower income tax returns in terms of income level, higher income being more complex. First, a word from our sponsor. Yeah, actually, we're sponsoring ourselves on this one because apparently the merchandisers, they don't want to be seen with us. But that's okay whatever, because our merchandise is better than their stupid stuff anyways. Like our Accounting Rocks product line. If you're not crunching cords using Excel, you're doing it wrong. A must-have product, because the fact as everyone knows of accounting being one of the highest forms of artistic expression means accountants have a requirement, the obligation, a duty to share the tools necessary to properly channel the creative muse. And the muse, she rarely speaks more clearly than through the beautiful symmetry of spreadsheets. So get the shirt, because the creative muse, she could use a new pair of shoes. If you would like a commercial free experience, consider subscribing to our website at accountinginstruction.com or accountinginstruction.thinkific.com. Lower income usually being easier, although it can be quite complex these days as well with things like the earned income credit. And are you focused on business returns or not? Business returns could include a sole proprietor that we'll talk about here, but also could include a partnership, in which case you'd have a separate flow-through entity and S corporation, which has basically a flow-through entity and a limited liability company flow-through entity or a schedule C type of, I'm sorry, a C corporation, which would be a separate basic legal entity, which is taxed at the corporate level. So the idea would be if you take on those business type of entities, there's usually going to be a lot more kind of tax planning work that will be involved and possibly more accounting work. So you're going to want to have a team together as well thinking, do you want to do the accounting, helping out with the accounting, or do you want someone else to be doing the accounting, give you the information for the data input, so just do the data input for the taxes and how much tax planning type of work might you be doing, noting that even when you're talking about just a schedule C, it creates a lot of changes to the tax return because now we have to work, think about different deductions, different credits, and we also have the self-employment tax possibly being involved. Okay, that said, a sole proprietor, your business income is reported on your personal income tax return using schedule C, form 1040, or schedule C, EZ. Now, so the schedule C is basically an income statement in and of itself. This gets confusing, I know, because we're talking here and said that the formula for the income tax equation is basically a funny income statement, income line items minus the deductions, but now we're saying that one of the lines that feed into this income line, in other words, one of the lines that feed into this top line of the income formula is actually coming from another statement, which is basically an income statement. In other words, it's coming from a schedule C, which is basically your business's income statement, which has business income minus expenses. The expenses on your business income statement are basically deductions. So what you're pulling into line one of income of this income tax formula is basically the bottom line, the net income, in essence, of your business's income statement, which is reported on the schedule C if we're talking about a sole proprietor. That's the general idea. Okay, schedule C, profit or loss from the business. So business income, report all income from your business, including sales, services, and any other income sources related to your business activities. Now note, when you're talking about a business, it's going to be more complex to determine what income is there, because when we talk about a W-2 income, 1099 income, note that the IRS is quite good, has become very good at forcing the payer to report to them the income earned if you're talking about an employee. The IRS already has the information. They got the W-2. They have the 1099s in certain cases for a contractor. When you're talking about a schedule C, it might be the case that you get 1099s, but you might not get 1099s that add up to the full amount of the business income. For example, if you have a nail salon business or if someone's a hairstylist or possibly a restaurant, a masseuse, those kind of things where they're getting paid by people that are in the customers rather than getting paid by a business, then the IRS has no leverage to force the payer to give a 1099 for those payments because they don't get a deduction. You don't get a deduction for getting your haircut. So therefore, you might not get 1099s for those types of businesses, and many businesses are that way. If you're doing business and you're working for another corporation, like you make widgets for a larger corporation, because it's a larger corporation, they're going to want to deduct the payments that they're making to you even though you're not an employee, the IRS is going to force them to issue a 1099 and you might get 1099s in those cases. Therefore, the IRS is skeptical about those businesses that are cash-based that work for the end customer like restaurants, hair salons, nail salons, all the ones that got hit during COVID, which I still think my conspiracy theory, the government took that as an advantage to take out those businesses. They don't like those businesses because they can't track them as easy. But anyway, expenses deduct all ordinary and necessary expenses incurred in running your business. This includes costs such as rent, supplies, advertising, utilities, wages paid to employees. It's very important that if you have someone that has a Schedule C business that they file their tax return, especially if they get 1099s, and they report their expenses. Because remember what the IRS is going to receive, they're going to get the income side because they might get 1099s reporting the income that someone paid to the business. If you do not file a tax return, what will happen is you are going to the IRS is going to see the income side but not the expense side. This is often where people get in deep trouble with the IRS over years because they just don't file their tax return and they don't really understand the whole consequences of not doing that because they've always been a W-2 employee in which case we have trained people not to really understand their tax consequences because we force the employer to take the money out of their wages for them. So they've been trained not even really to think about it. When they start a new business oftentimes, they don't keep up with their tax obligations possibly and then they get hit with possibly the IRS saying that they earned like 100,000 of income when really if they had all the expenses that they wrote off, it would be a lot less, right? Because the IRS only has the income side of things, not the expense side of things. So you've got to make sure that you're tracking the expenses and reporting it so that you can take advantage of those on the taxes so you can report your net income which is the fair thing to report and pay taxes on, not the gross income. So net profit or loss subtract your business expenses from your business income to calculate your net profit or loss. This figure is then reported on your Form 1040 and is subject to income tax and self-employment tax. We sneak that one in there, right? Because it's also subject to self-employment tax which adds a significant level of complication to the tax return. Remembering self-employment tax is similar to payroll tax, meaning it's basically social security and Medicare. When we talk about payroll tax, once again the IRS has forced the employer to do the withholding so the employee doesn't really think about it. We see it on the W-2 but it usually doesn't have an impact on our taxes unless like we overpaid because we had multiple jobs of social security or something like that. But for sole proprietor then we haven't paid in, we don't have the payroll so the government can't take the payroll taxes so they want to take the payroll taxes in another format, that being self-employment tax resulting in the Form 1040 not only calculating the taxes that we owe for federal income taxes but now the social security and Medicare taxes which again is significant. So self-employment tax. We'll talk more about this when we get to the Schedule C but we'll just touch on it here. So sole proprietors must also pay self-employment tax that's social security and Medicare if their net earnings from self-employment exceeds $400. So if you lost money then you might not have to deal with that, right? But if you made more than $400 then you might have to deal with self-employment tax which is obviously a fairly low threshold which I don't think has been increased for years. That's why it looks kind of ridiculously low. So this is calculated using the Schedule SE, so Form 1040. So half of your self-employment tax can be deducted from your gross income on your Form 1040 which can reduce your taxable income. So now you're probably saying like what? So you're telling me I have to pay income taxes which is going to be reported by going to the bottom line of the Schedule C net income flowing into the first page or eventually to the first page of the Form 1040. I pay income taxes on that and you're going to calculate self-employment taxes that we'll talk about. But then I get to deduct half of the self-employment tax. Where do I get to deduct half the self-employment tax? Do I deduct it on the Schedule C as a business deduction? And the answer is no because if you deducted it on the Schedule C it would have an impact on net income which is what the self-employment tax is calculated on making a circle reference. So you have to deduct it somewhere else so it's going to be an above the line or adjustment to income. We'll see a tax software example of this in the next presentation. But just to touch on again there's a lot of kind of components that are changed even with a fairly basic Schedule C. So home office deduction just to note if you use part of your home exclusively for business you may be eligible to claim the home office deduction which can reduce your taxable income. Oftentimes small businesses work from home and so that's just going to add another level of complexity to calculate the expenses for the home office because normally if your home is a personal expense not deductible for taxes except we have exceptions for that like the mortgage interest for some reason. Basically it's just to prop up the housing industry. I think that's the original reason that happened. But normally you don't get to deduct the home but if you use your office for home then you might be able to deduct some of the home office expenses like utilities possibly and part of the mortgage interest might go then to the home office and the Schedule A one and or the other. You have to split them between the two in some way, shape or form and you might even have depreciation and so on which we'll talk about again at a later point. So quarterly estimated taxes. So since taxes are not withheld from your business income as a sole proprietor you may need to make quarterly estimated tax payments to cover your income tax and self-employment tax liabilities. So in other words this is where a lot of people get into trouble because they're W2 employees. They've been trained not to think about taxes. It's not even my responsibility. The employer does it. Everything happens automatically. But when you go from a W2 employee to a sole proprietor you have to pay your own taxes and actually painfully write that check or do the electronic transfer these days to the government and you have to do it during the year, not at the end of the year which means you don't even know how much tax you owe especially if you're a new business because you might not even be making money. You might have a loss so you might not know how much you owe but if you do make money the IRS wants the money as you earn it you can't just wait till the end of the year and pay them. Why not? Because they hit you with the sticks of penalties and interest not physically, metaphoric sticks, penalties and interest. They still hurt. They still hurt. So you try to avoid that by paying them taxes. Now again you might say well how much do I pay them? What's my tax rate? Well I don't know. It's progressive. It's a progressive tax rate so we don't know. So what if I made like 10,000 in the first month or something? Do I pay them like, there wouldn't be any tax because that's below the progressive tax threshold possibly I might not owe any tax. Well no you have to average how much you're going to make for the entire year so that you can properly calculate what the average tax would be on your yearly income rather than on like your monthly income. It's like well I don't know how much I'm going to make. That's the problem right? So that's why this is why the progressive tax system being more and more complicated does cause problems and probably decreases the gross GDP because again it's uncertainty. We don't know. We can't really tell what's going on. So that's the game we kind of have to play. Figure out how much you're going to pay. Try to overpay a little bit to avoid getting hit with the sticks of penalties and interest. So use Form 1040ES to calculate and pay these estimated taxes. Additional considerations depending on your business type and location. You may be subject to other taxes or reporting requirements such as sales tax or local business taxes. So remember we're talking here about the federal income tax and we tacked on to that self-employment tax which is kind of equivalent to payroll tax, social security and Medicare but in the state you might also owe state taxes which they might use a state income tax but they also might use a sales tax or have some other business tax that they hit you with. So consider consulting with a tax professional to ensure you're taking advantage of all eligible deductions and credits and complying with all tax laws and reporting requirements. Let's look at the line instructions. Line four, other gains or losses. So if you sold or exchanged assets used in a trade or business see the instructions for form 4797. Who needs to file form 4797? Taxpayers who sold or exchanged business property including real estate used in a business. Taxpayers who received business property from a casualty or theft. Taxpayers who disposed of depreciable property used in their business and taxpayers who sold certain types of business property that cannot be depreciated. So note when you talk about business property we have an income statement on the Schedule C. We don't typically have the balance sheet reported as it's liabilities equity. We just have the Schedule C which is the income statement because we have an income tax but so you would think that you would just expense things as they happen which would normally people would think of a cash based system which might be usable although there could be exceptions if you have a substantial amount of inventory for example and what not which we'll talk more about those later but even if you're on a cash based system sometimes you have to do a cruel things meaning for example if you buy property, plants and equipment you have to put it on the books as an asset instead of expensing it because there's such a big difference in timing difference between the point in time that you actually use that stuff versus the time that you purchase it and so now you have to deal with depreciation if you have depreciable assets and then when you sell those assets then you might sell them at a gain or a loss and then you have to deal with the calculation of the sale or disposal of depreciable assets not all small businesses might not have to deal with many depreciable assets depends on the type of industry you're in if you just have gig work for example you might not have a whole lot of depreciable assets because you might not have very limited things that you're using for the business that are long term assets in any case we'll talk more about that later in the Schedule C section just to point it out here IRS Form 4797 quote sale of business property end quote is used to report the sale, exchange or involuntary conversion of property used in your trade or business and certain depreciable property this form helps taxpayers calculate the gain or loss from these transactions and determine how the gain or loss is treated for tax purposes e.g. as ordinary income or capital gain so in other words one of the things is when you sell property it's kind of like when you sell stock it's usually going to be a categorized as capital gains and we talked about the idea that sometimes you could have beneficial treatments in terms of tax rates that are more beneficial than the normal ordinary income progressive tax rates and capital gains sometimes falls into that category in part because like if you sell something that went up in value like a building then the building even though you sold it like this year it might have increased in value over the last 10 years and so if you sell it this year and you got a gain of $100,000 that $100,000 might put you into a much higher tax bracket because you're recognizing all the gain this year whereas if you were able to recognize the gain over the last 10 years because we have a progressive tax system it might not have put us up into as high a tax bracket that's just one kind of argument as to why we might have capital gains taxed at different rates if we did not do that then you would feel like you don't want to sell the property because it's going to push you into these large high tax brackets which would have a downward or dragging effect on the economy because people would be reluctant to trade and whatnot so key sections of Form 4797 Part 1 so used for reporting the sale of property held for one year or less these are short term gains or losses which might be more likely taxed at the ordinary higher tax rates rather than a preferential tax rate so Part 2 used for reporting the sale of property held for more than one year long term gains or losses Part 3 used for calculating the ordinary gains and recapture amounts for certain types of properties such as depreciable real estate and equipment that has been depreciated so this recapture thing is a whole nother kind of topic in and of itself because what ends up happening is if you buy like equipment and then you depreciate the equipment and usually the IRS has accelerated depreciation methods they might give you like even a 179 or special depreciation when you deduct the depreciation you're getting a tax deduction at ordinary income tax rates but what if you sell the property then and you have a gain well if you had a gain then it seemed then you might have over depreciated the property right which is likely to happen because they have accelerated depreciation and if you're able to recognize the gain at favorable tax rates meaning not ordinary income tax rates but lower tax rates it would lead people to try to manipulate the tax system possibly by taking larger deductions for depreciation at ordinary income tax rates and then trying to then recognize the sale at capital gains rates and so now you have this whole recapture thing because of the changes in the tax rate which again is these things like the progressive tax rates having these tiers of taxes and then having different tax rates entirely for things like capital gains and like qualified dividends and things like that you would think that they seem pretty straightforward but the rippling effects that they have when you're trying to do tax planning can be significant the things add up things get complex over time just because of the varying factors they come into play in the moving landscapes that happen with them so part number four used to summarize the information from parts one through three and calculate the total gain or loss to be transferred to your income tax return important instructions determine the correct part to use depending on the type of property sold and how long you held it for you will use different parts of form 4797 to report the transaction was it long term, short term do you have recapture involved calculate the basis so the basis is kind of like the cost of the property but it could be a little bit different than the cost depending on because you might have done something to the property which could have altered the basis but in essence the cost of the property when you sell property how much did you buy it for how much did you sell it for most equipment you would think you would sell at a loss because you bought it and then you sold it at a price that's less than what you bought it for but you also have depreciation so we're really talking about the depreciated cost that you sold it for depreciation could be accelerated oftentimes in the tax code which could result in having a lower kind of basis that you're calculating the gain on so to determine your gain or loss you'll need to know the property's basis which is generally it's cost adjusted for improvements depreciation in any prior year losses okay so then we have the recapture of depreciation some or all of the gain on depreciable property may be treated as ordinary income due to depreciation recapture rules especially for section 1245 and section 1250 property so again if you sold equipment at a gain that would think it would lead to believe that you over depreciated it because you were allowed to do so with accelerated depreciation getting favorable tax rates on the deduction resulting in the IRS wanting to recapture or tax the gain at those same ordinary income tax rates as opposed to more favorable or lower tax rates on the okay so reporting to other forms depending on the transaction you may also need to report gains or losses on other tax forms such as schedule D form 1040 for capital gains and losses schedule D most commonly used for individual taxpayers to report like sales of stocks and bonds for example