 Income tax 2022-2023, figuring net profit or loss. Let's do some wealth preservation with some tax preparation. Support accounting instruction by clicking the link below, giving you a free month membership to all of the content on our website, broken out by category, further broken out by course. Each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files, and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Most of this information comes from the tax guide for small business for individuals who use Schedule C, Publication 334 Tax Year 2022. You can find on the IRS website, irs.gov, irs.gov, looking at the income tax formula. We're focused on line one, income. Remember on the first half of the income tax formula is in essence an income statement, but just an outline, other forms and schedules flowing into these line items, one of those being the Schedule C. The Schedule C having business income minus business expenses gives us the business net income, which flows in from the Schedule C to line one income of the income tax formula. When we look at the actual form 1040, we remember that the Schedule C flows into the Schedule 1, which flows into the first page of the form 1040 line number eight. The Schedule C is the profit or loss from business has an income tax income statement, structure income minus expenses. We're focused now on the figuring of profit or loss in essence the bottom line of the calculation on the Schedule C. Alright, so figuring net profit or loss introduction after figuring your business income and expenses, you are ready to figure the net profit or loss from your business. You do this by subtracting business expenses from business income. That part of course seems fairly straightforward because once again it is an income statement, structure where you have income minus expenses gives you that net income or loss if there's a loss. If your expenses are less than your income, the difference is net profit and because part of your income on line three of Schedule 1 form 1040, so once again if your expenses are less than your income, that means you have more income than the expenses you have income that's going to be flowing through then and be taxable typically ultimately going into the first page of the form 1040, increasing your income to be taxed. The difference is net profit and becomes part of your income on line three of Schedule 1. So it flows in from Schedule C to Schedule 1 and then from Schedule 1 onto the first page of the form 1040. So if your expenses are more than your income, the difference is a net loss. Now that's when things get actually messy when you have a net loss because remember the IRS is going to be skeptical of losses. The IRS wants to be your silent partner but only when you have income but they don't want to take on the risks when you have the losses. So because if you have a loss then you might be able to take the loss against other types of income such as other W-2 income or investment income or something that you have elsewhere and that's where the IRS is going to be skeptical of the losses. So there could be restrictions as we've talked about in various kind of various areas along the way with regards to losses and the possible use of like certain type of expenses such as the business use of the home being limited in some cases if you're in a loss scenario. We also talked about the situation of whether you have a business or a hobby. Remember that just because you have a loss doesn't mean you're not necessarily a business but the losses if you have losses for an extended period of time in particular the IRS is you would expect it going to be more skeptical and you might have to prove then that you have business intent which is revenue generation intent. But and if it's not if it's not revenue generating activity then you might have a hobby kind of situation rather than a business income situation but if you are legitimately trying to build a business then it's quite common in the first couple of years to have a loss. So you don't want to be overly worried about the loss as long as you can prove in the event that an audit happens that you are actively seeking profit. So you can usually deduct it from gross income on line 3 of schedule 1 form 1040 but in some situation your loss is limited. This chapter briefly explains three of those situations. Other situations that may limit your loss are explained in the instructions for schedule C line G and line 32. So caution if you have more than one business you must figure your net profit or loss for each business on a separate schedule C. So it's quite possible that you have multiple types of businesses that are different in nature and then you would have to file two schedule C's which in essence if you had two or more businesses you would have at least two instead of one if it was more than one then you would have two schedule C's which would in essence be two kind of separate income statement type of formats which would both then have to flow into all the different components we talked about self-employment tax having to be calculated and the schedule 1 and to the first page of the form 1040 and so on and so forth. So excess business loss limitation. So your loss from a trader business may be limited. Use form 461 to determine the amount of your excess business loss. If any your excess business loss will be included as income online AP of schedule 1 form 1040 and treated as an NOL net operating loss that you must carry forward and deduct in subsequent years. So when you hear this term of an NOL so now you have a loss and you're not getting a tax benefit from the loss. You've limited the loss for whatever reason and now you have this NOL. So whenever you have a loss that you're not being able to get a benefit from you can imagine like why would this happen. Well if it was a new business and it's quite likely that I have a loss for like the first two to five years for depending on the type of business but in the future years the investments that I put in those ground level years that the business set up is hopefully going to generate more revenue into the future. So if you have those years that you have losses that you don't get the benefit from the losses then you're really not getting any tax benefit for the things that the ground work that you had to lay down in order to generate the revenue in the future. So the idea should be hey look obviously the IRS isn't going to pay you possibly for losses typically is the general idea but you would like to be able to match up the losses that you had to the revenue that you're going to be generating in the future years that seems kind of fair to do. So it used to be that you might have thought well can I carry it back or carry it forward currently we have the NOL that you must carry forward. So if you had income in the following year then you might still get a tax benefit from the loss that was disallowed in the current year. Note that if you're using tax software this carry forward kind of structure is where you really want to be careful as a tax preparer to make sure that you're picking up the carry forward properly and often times I would recommend trying to put the tax return in the prior year tax year software if you have a new client to restructure the prior year so that the rollover will the software will help you with these rollovers. Alright so for more information about the excess business loss limitation you'll see form 461 and its instructions. Net operating losses in OLs. If your deductions for the year are more than your income for the year you may have an NOL and net operating loss. You can use the NOL by deducting it from your income in another year or years. Examples of typical losses that may produce an NOL include but are not limited to losses incurred from the following years. If you're a trader or business that's what our major focus is on here the Schedule C a casualty or theft resulting from a federally declared disaster moving expenses or rental property. So a loss from operating or operating a business is the most common reason for an NOL. The Schedule C most common reason you have a loss on your business on the Schedule C. So for details about NOLs you can see publication 535 6 publication 536 you can find on the IRS website irs.gov. It explains how to figure an NOL when to use it, how to claim an NOL deduction and how to figure an NOL carryover. Obviously software helps with those components as well. So not for profit activities. If you do not carry on your business to make profit there is a limit on the deductions you can take. You cannot use a loss from the activity to offset other income activities you do as a hobby or mainly for sport or recreation come under this limit. For details about not for profit activities see chapter 1 of publication 535. So when you're setting up the business the idea is going to be well is it a profit seeking endeavor? Are you doing it to generate revenue or is it kind of a hobby that happens to have income as well. The classic example of this was the horse racing back in the day. I guess for some reason the rich people liked to have own horse racing horses and what not which apparently was quite expensive and not exactly profitable although there was income involved sometimes. So they would run long extended periods of losses as a business as if it was a business endeavor when it really looks like a quite expensive hobby possibly. So you can imagine different businesses where you're going to have that line where is it a hobby or not like if you were a photographer on the side or something and you take a lot of nice vacations and travel around is it but you might have another income or something then you could be in one of those gray areas as to okay is it an actual hobby or is this a business and you want to be able to make sure that you delineate that line because you don't need to be scared of having losses per se if you do have a business intention but you want to be able to prove that you do have a business intention in the event of an audit. Other types of businesses are pretty more straightforward. Obviously if you do tax preparation or something like that nobody does tax preparation as a hobby generally. So the IRS is less likely to say that your tax business looks like you're doing that for the simple joys of life although tax preparation can be fun you know but it's that that's probably not usually the case but if you're a if you're a horse if you're buying horse if you're a horse racer or if you're you know traveling the world as a photographer on the side or something like that and you have a lot of losses for multiple years you can imagine the IRS being more likely to say hey look I'm sitting in here in the office that doesn't look that doesn't look like a so so again it might be a business thing but you want to make sure that you make the argument. So anyways the chapter explains how to determine whether your activity is carried on for profit and how to figure the amount of loss you can deduct.