 Income tax 2023 2024. Schedule C impact on tax return tax software example. Get ready and some coffee because tax preparation is like a choose your own adventure novel except every choice leads to more paperwork. Here we are 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 but that's okay whatever because our merchandise is is better than their stupid stuff anyways. Like our trust me I'm an accountant product line. Yeah it's paramount that you let people know that you're an accountant because apparently we're among the only ones equipped with the number crunching skills to answer society's current deep complex and nuanced questions. If you would like a commercial free experience consider subscribing to our website at accounting instruction.com or accounting instruction.thinkific.com. In our form 1040 example problem using the LASERT tax software you don't need tax software to follow along but if you have access to tax software it's a great tool to run scenarios with. You can also get access to forms schedules instructions at the IRS website at irs.gov irs.gov. We're gonna start with our standard starting point our taxpayer Adam tax man just trying to avoid a dang tax man living in Beverly Hills 90210 noting that we are focusing in these example problems on the federal income taxes and not on state income tax returns. We're gonna start with a single filing status no dependence we have the W2 income to start out with which we will then compare and contrast to a small business or schedule C type of income standard deduction at the 13850 taxable income then therefore at the 86150 which we can also see an income tax formula standpoint using our excel worksheet where we have the income 100000 standard deduction 13850 getting us to the taxable income 86150 tax calculated by the software then at 14266 back to the software page number 2 here is that calculation. Let's go back to the first page now note you might be asking hey if we're going to be talking about a schedule C's sole proprietor type of business why did we start out with W2 income because we want to start off with a basic kind of scenario to compare and contrast what it would look like if we had the schedule C income of for example 100,000 as opposed to W2 income of 100,000 and as we will see there's a significant amount of change and complication when we add a schedule C to a tax return which leads us to the question and something that we want to plan for if we're a tax preparer or if we're doing our own taxes the question is how much help do we need if we're doing tax preparation what kind of clients do we want to be taking on some strategies that you might keep in mind is some people do lower income more simple tax returns where you're not going to get as much profit per tax return but they're easier to do and you can crank out a whole lot of them if you can get if you can pull in the clientele another strategy would be to focus on higher income tax returns where you're not going to be able to do as many because they're complicated but you're going to have a higher profit margin per return and be picking up money for things like tax planning because of more complex situations with more wealthy individuals they're going to need more kind of tax planning work than possibly lower income individuals often times and then you also might focus in on whether you're going to have business tax returns or not focus in on business tax returns which are kind of in the middle you might think that a schedule C type of business would be something that more wealthy individuals would have but that's not always the case of course you could have a small or lower to moderate income individuals who have the schedule C type of business do we want to be taking on that type of business or not and if so what kind of support do we want with that kind of business because we not only have the data input that we'll have to deal with in the tax return which we will see here is significant but another thing you want to keep in mind is the bookkeeping perspective of it because particularly on the lower income side of things where people are doing their own books we often deal with people who aren't great at that so you might to give them the best service it would be nice if you can kind of help them to clean up the books which gets you into the whole bookkeeping area so often times when you get into that area you might have someone else to help you with that supporting area that does bookkeeping or specializes in bookkeeping or a lot of times accountants or CPAs tend towards business tax returns because they have a double entry accounting you know background and that's the kind of work that they kind of like to pick up no matter what kind of books we get from the client we still are going to have to do some bookkeeping to China to try to shore up our books and I'll try to show that shortly because they will often have like a home office or a car that we need to be deducting the mileage where we have a mileage method which is different than how they entered in the tax return so bookkeeping becomes important at least to some degree even if you have good bookkeeping that has been done on the client side you can also specialize by industry so some industries are going to be a lot more complex if you deal with industries that have inventory inventory complicates things a lot so you you might want to say what kind of industries do I want to specialize in which do I not want to specialize in if you deal with construction companies that have a percentage of completion method that can be more complex as well the other thing that you that you could specialize in is the type of tax return do you want to just be picking up people that have a schedule C sole proprietorship type tax return or do you want to have an advise on possibly and help out with other kind of business entities that could be set up such as flow through entities like an S corporation or a partnership or even C corporations which are separate legal entities that are not you know the flow through type of end and when you get into different kind of structures of businesses like that as corporation LLC oftentimes you might specialize in particular industries that tend towards certain formats of entity structure given the needs of that particular industry so you may notice that certain industries tend to have an S corporation structure versus an LLC structure certain states might have certain industries that might have more structures tending towards one or the other so those are all areas that you can specialize in those are also all areas that you might work with other people to have as part of your team and possibly also to be able to advise people to so that you can stay out of those areas if they're not where your where your profit margin is if that's not your business if your business is not doing complex tax returns and you're trying to focus on cranking out tax returns then you have to be able to say no to the clients that don't fit your business model which also is often difficult for many people. Let's first start off by just saying what if I just had a simple schedule C and I went from this W2 income to someone working exclusively in their own business and having all of the money on a schedule C versus a W2 noting that this will not always be the case because many times you'll have someone that has W2 income and then a schedule C business on the side which oftentimes is going to be an easier situation because the schedule C business is probably not as complex and you don't have to deal with other kind of things like like an IRA or seps and whatnot because they might have access to a 401k through their employer as well as health insurance and that kind of thing but first let's say let's remove the whole W2 income say that's gone and instead we're going to say that they have a schedule C so we're going to say all right schedule C and I'm not going to get into the type of business right now I'm just going to go right to what if we just had 120,000 of income and then expenses of 20,000 which will net out to that same amount of 100,000 going back to my forms and then we can go basically to the schedule C here so now I'm just looking at the income statement so now we have income 120,000 expenses of 20,000 this is the first thing that will of course add complexity to a schedule C in that when we think about an income tax system the schedule C actually makes a lot of sense because we don't want to tax people on the gross income 120,000 in this case but the net income 100,000 we want to allow those types of deductions that are necessary in order to generate the revenue because those are natural deductions for an income tax type of system so you have an income statement here income minus ordinary and necessary expenses which is going to be basically business deductions gets us to the net income and that's ultimately going to be flowing through to the form 1040 so now it's going to be flowing through the form 1040 here instead of up top now normally when we have W2 income it's kind of confusing the types of deductions we get there are different because you might say hey look I have some expenses that I have for W2 income why don't I get to write those off the idea is because of course your employer is supposed to be the one that's providing those kind of expenses therefore you don't have an income statement you don't write those off and most of the deductions we think about are things like on the schedule a which are unnatural to a federal an income tax system right because these are personal things that we get deductions for for whatever reasons from the government like medical expenses right that's personal taxes that you paid or typically personal interest on your home for example is personal unless you use it for a business so why do you get these deductions because the iris is manipulating our behavior for whatever reason whether that be good or bad for lobbyists or whatever whatever it is charitable and stuff right these are weird kind of deductions the schedule see is actually makes sense because now we're saying this is the income that I have these are the expenses that I had to generate it now of course we have to track the expenses that becomes the difficult part that's where the bookkeeping comes into play if you're in a large business you're going to get possibly 1099s that add up to the income or if you're in a business that is dealing with other larger businesses then you will typically get a 1099 as a sole proprietor and if you report income less than what the sum of your 1099s are you'll probably going to get a letter from the irs they're going to be contacting you because they have that information in a similar way as they do have the w2 for a sole proprietor however if you're in like a hair salon or a massage parlor the restaurant it's likely that you didn't get a 1099 because the in people you're getting money from are individuals not other businesses and those are the businesses the iris is skeptical of they tried to crack them all down during covid I think I feel like that's why they they went after the restaurants and whatnot and the and the little hair salon the masseuses because they're the people that I have my personal opinion they're the people that the iris doesn't like because they get they get payments from cash from customers which it's harder to track you know but in any case that that's the income side of things now the expense side of things you're typically not going to have any information that's given to the irs on the expense side of things that means it's up to you as the tax preparer and and the taxpayer to track your expenses so that you can deduct them otherwise you're going to be taxed on gross income which will be very bad right that's that's often where people come into tax problems they have 1099s have a schedule C business the iris knows about it comes after them and the iris doesn't know about all the expenses because they have no information on the expense side of things and that is something we really if you're a tax preparer you almost have to train your your clients who aren't good at tracking this information in part because they've always been trained as a w two employee as a w two employee you don't even think about taxes really because you just get it pulled out of your pages your wages and you actually think of tax season as good because the iris is usually going to give you a refund but if they move from a w two to a schedule C then they often get whacked because they don't do withholdings or estimated payments properly they don't record their expenses properly and the iris will come after them for gross income so the bookkeeping becomes very important so we have to make sure the bookkeeping is right so that we can at least do the data input and basically be an income statement notice the balance sheet is not here we only have an income statement so you might say why would I use QuickBooks or anything like that which has a full financial statement balance sheet and income statement it's because you still want to use the double entry accounting system so QuickBooks or any other kind of accounting software that has a double entry accounting system really helps you to verify that your income statement is accurate otherwise you're just kind of kind of winging it right you're putting together an income statement without a double entry accounting system which has a lot lower level of assurance alright so this amount here the net income is going to pull through to the schedule C you can see it I'm sorry the schedule one additional income and adjustments to income part number one it's pulling through line number three business income or loss which is attached from the schedule C there's the 100,000 it then is going to be summed up at the bottom let's get rid of that check mark and it rolls through to the 1040 as we saw the 1040 now online eight instead of line one the end result that was the same so you might say well the bookkeeping is difficult but we're ending in the same spot but no we're not why because what is this amount this amount wasn't there before that changes my adjusted gross income and then my standard deduction is the same but what is this whole thing qualified business income deduction that is different and that gives me a different subtotal here so my taxable income is different and then on page two I've got tax of nine thousand two twenty eight which is a lot lower than what it was before so that's good but what is this I've got another other tax down here other than my income tax of fourteen one twenty nine which brings my total tax to twenty three three fifty seven so let's say twenty three three fifty seven so that's bad right that's that's higher so what is going on here so so so there's a lot of changes that are happening even if we get the income statement in there and we get into our net income so what are those changes what is going on all right the first thing we really have to basically drill down in our mind and understand is that this net income is also going to be subject to self employment tax self employment tax is the equivalent kind of a payroll taxes but most people don't really think about it when they're W two employees because once again it just gets pulled out of their earnings and W two wages and you're just like okay whatever they're going to take money out of it so if we if I went back on over here remember when I entered the W two if I said this was a W two and I said one hundred thousand of income then it tries to calculate social security automatically it's kind of a flat tax at six point two percent that comes out to six thousand two hundred and the Medicare at one point four five comes out to one thousand four fifty these two amounts if I have W two income don't really impact the tax return because we already paid it so it's just informational information on the W two that we put in here typically but if we don't have a W two we don't have an employer then the government wants us to pay it now notice what we paid here six thousand two hundred plus one four five oh is seven seven thousand six fifty so okay so let's delete that and go okay well then they want us to pay that on our side as an employee a schedule C so let's delete this so I'm going to go okay well then let's see how that works we go to the schedule S E so first you might say hey wait a second I'm not an employee I I have wages here to pay people but I didn't pay myself and the IRS basically their position is well you are the primary worker you're the labor of your business therefore if you have net income after you pay your employees if you paid your employees then you would be social security and Medicare or they would and you would be matching it in a similar way as a business uh a corporation for example but the money that you got in net income we're going to assume that you are basically acting as an employee of your own business therefore you need to be paying the tax on it and that would be the seven thousand six fifty about right but you are also the employer so we want you to pay both the employee and employer portion on in essence your net uh tax here so if I go to the self-employment tax then we've got the one hundred thousand you I won't go through the calculation we'll talk about it later but here it is the fourteen uh two one twenty nine it's like whoa wait a second I thought we are only paying seven thousand six fifty because they think of us as both the employee and employer so that's a big difference when people are going from a w two employee to a schedule c if they make the same amount of net income then the self-employment that the social security and Medicare are basically almost twice as much not exactly we'll go over the calculation later but you can see it's a lot higher and like and so that's going to be a significant uh impact because because most people just think of taxes as federal income taxes so that then this line twelve pulls into uh the schedule uh one will note pulls into the schedule two and the schedule two is the additional taxes part two other taxes self-employment tax that's going to sum up and it's going to go then to to do to twenty one and then it goes to the form ten forty page number two that's where that fourteen one twenty nine comes in that's huge but you might say well wait a second if I was a C corporation then the portion of taxes that I pay I would get half of that as a deduction that's how it basically works because it would be on the income statement I should be able to deduct my portion of the self-employment tax like like I like I would if it was like wages of my employees if you treat me as an employee of myself I should be able but I can't deduct it here because then it would change this number which would cause a circle reference when I try to deduct it calculated over here so I can't deduct so I'm going to take my half seven thousand sixty five that I should get a deduction for because we're trying to mirror what would happen in a C corporation but I'm going to get that deduction as and above the line deduction so now I've got my schedule one page number two adjustments to income that's where that seven thousand sixty five comes in so if I go back to the form ten forty and say okay what's going on now we've got the one hundred thousand minus the seven thousand sixty five that's where that seven thousand that gets us to my adjusted gross income has now changed to ninety two nine thirty five the standard deduction is the same and then I've got this qualified business income deduction which is a whole mess in and of itself which I don't want to dive into now but obviously it's quite significant because it's a it's a large dollar amount and this was an impact of one of the changes made a few years ago and attempt to simplify the code which it did in part but you always have these issues when they're trying to figure out how to deal with taxes for corporations and S corporations versus a sole proprietor and this was kind of like a plug that they used to kind of fix fix that problem so then we have that we're going to have to deal with qualified and so that gets me to the taxable income which is on page two here and here so let's just try to mirror that in our Excel worksheet so we're going to say okay income instead of having that income there I'm going to delete it from there w two and I'm going to pull it in from my schedule C which I'm going to just make an income statement one hundred and twenty thousand and let's say twenty thousand here now we don't have to have like I could make a whole another worksheet to create an income statement so I can do my bookkeeping which I would recommend doing but I won't do that here I'm just going to try to get to that hundred thousand that pulls into line one all right that makes sense but then I'm going to have to calculate my taxes which is going to be other taxes over here so I'm going to let the software calculate it so I'm going to go back on over and say my self-employment tax was fourteen one twenty nine so I'm going to say fourteen one twenty nine does that make sense well it's about fourteen percent of my income from my self-employment income which makes kind of sense because if it was if I'm the employee and the employer it would be six point two plus six point two for social security one point four five plus one point four five so about fifteen point three so it's a little bit different than than double you know what you would pay for w two if you were an employee which makes sense because they're treating you as the employee and the employer so that pulls in to here on the form ten ten forty as the other tax so this tax down here and so that comes out to twenty eight that's where we are right now but then we also have half of that that's deductible above the line right there which is populating for me already so if I go into the adjustments to income I'm going to have then the deductible self-employment tax this calculation is just taking the number that was pulled in the schedule C and dividing by two so half of that is pulling in so that's good that's where we got to ninety two nine thirty six so that's going to be so uh ninety two nine thirty six standard deduction is still at thirteen eight fifty I'm just going to plug this number in for now letting the software doing the calculation for the qualified business income deduction fifteen eight seventeen so I'm going to say right fifteen eight one seven and that gets me to the six three two six nine so six three two six nine page two calculated the tax I'll let the software do that federal income tax at the two the nine two two eight so this is now at nine two two eight which is a lot lower but I also have to include the self-employment that brings me to the total tax of the twenty three three fifty seven twenty three three fifty seven so the point is there's a lot going on even if we just have a the bookkeeping is simple and we just basically pull in this one hundred thousand here obviously the bookkeeping adds a lot of information in detail on it and some bookkeeping that you're going to have to do even if you get a solid income statement is usually going to include the car and truck because they might want to use a mileage method and that means that you're going to have to adjust their accounting to deal with a mileage method they also will often have like a home office situation in which case you're going to have whatever bookkeeping they do you're going to still have to take their information to calculate the home office which is often kind of an issue and if they have depreciable items then you're going to have to deal with the depreciation which is often kind of a kind of a pain for many people if we're not comfortable with doing depreciation and it could mess up or complicate your schedule a if they're itemizing because if they're using a home office it's going to have an allocation between the loan the mortgage interest that might be on the schedule a versus the schedule c as well as the property taxes and then you also have planning type of things that could come up such as if their sole proprietor business is their main business do they have health insurance and if not then you might be dealing with health insurance that might be self-employed health insurance that you might have to deal with and have questions about that as well as they don't have access to a 401k plan if they don't have another w2 so maybe they want to set up a 401k plan which is complex so then you can you get into the simple or the sep which are types of 401k plans and so on and so forth so you can see that uh if they're moving fully in from a w2 to a schedule c it's not just the bookkeeping the data input of the bookkeeping will still be complex you can't outsource all the bookkeeping because even if the bookkeeping was perfect you're still going to have to deal with like the home office and the auto expense and that kind of stuff and you you pretty much can't avoid the fact that you're going to have tax planning complex scenarios as well because of things like a sep or a 401k or a simple often being tied to the business right and things like the the self-employment which can be significant kind of planning uh areas so the point is that if you're doing tax preparation for uh businesses then what stuff do you want to pick up and what stuff do you want to have a team around you a network uh to be helping you out with and what clients do you want to avoid because their their situation doesn't line up to your tax preparation business and how best can you you advise them to go elsewhere without uh without being a jerk without them hating you or whatever which is not easy to say so those are some tips as we dive into uh as we dive into the schedule see also just quick note that you're always going to be dealing with people who who want to to also make uh businesses that are schedule c's into s corporations and llc's or even c corporations because and sometimes they have there's totally legitimate reasons to do that but again you need to be wary of that be aware of it because some people that they're just lawyers that like to set up s corporations and llc's whether it be warranted or not possibly and so you also have to be aware of those kind of things as well because you're always when you deal with these business situations there's always some person out there that's got the new bright idea that's trying to pull in clients or get people to sign into whatever it is that they are doing which which could be good could be bad but that's where you know the advice comes in and building trust with uh clients