IRS Publication 334: A Guide for Sole Proprietors Using Schedule C

Running your own business as a sole proprietor means navigating the often-complex world of taxes. Knowing what income to report, which expenses you can deduct, and how to handle various tax obligations is crucial for staying compliant and maximizing your financial health. The IRS provides Publication 334, Tax Guide for Small Business, specifically for individuals who use Schedule C.

While comprehensive, IRS publications can be dense and challenging to digest. That's why we've created this 101 guide to Publication 334. We'll break down the essential information from each chapter into straightforward language, helping you understand the key tax rules affecting your sole proprietorship without getting lost in the jargon.

What is IRS Publication 334?

IRS Publication 334 serves as a general guide to federal tax laws for self-employed individuals (sole proprietors, independent contractors) and statutory employees who report their business income and expenses on Schedule C (Form 1040). It covers essential topics like business income, expenses, tax credits, accounting methods, and self-employment tax.

How is IRS Publication 334 Different from Other Publications?

Publication 334 specifically targets individuals filing Schedule C. It provides broad guidance relevant to most sole proprietorships. It does not cover topics specific to corporations (Pub. 542), partnerships (Pub. 541), farming (Pub. 225), or starting a business and detailed recordkeeping (Pub. 583), among others.

A Breakdown of IRS Publication 334

The following sections summarize key information from IRS Publication 334. For detailed rules and official guidance, always consult the full publication on the IRS website.

Chapter 1: Filing and Paying Business Taxes    

This chapter covers the basics of your tax obligations.

What Identification Numbers Do I Need?

• SSN: Generally, you'll use your Social Security Number (SSN) as your primary taxpayer identification number (TIN) on individual tax forms like Form 1040 and Schedule C.
• ITIN: Nonresident or resident aliens ineligible for an SSN use an Individual Taxpayer Identification Number (ITIN). ITINs are for tax purposes only.
• EIN: You'll need an Employer Identification Number (EIN) if you pay wages to employees or file pension or excise tax returns. Include it on Schedule C if required. You also need TINs (SSN or EIN) for payees when filing information returns. Use Form W-9 to request a payee's TIN.

Do I Need to File an Income Tax Return?

You generally must file if your net earnings from self-employment were $400 or more, or if you meet other filing requirements.

How Do I File and Pay Income Tax?

• Report business profit or loss on Schedule C (Form 1040). Use a separate Schedule C for each distinct business.
• IRS e-file is encouraged for faster, more accurate processing. Benefits include security, proof of acceptance, faster refunds (often via direct deposit), and electronic payment options.
• Income tax is pay-as-you-go. If withholding isn't sufficient, you likely need to pay Estimated Tax using Form 1040-ES, typically quarterly. Failure to pay enough tax through withholding or estimated tax can result in penalties.

What is Self-Employment (SE) Tax?

This is the Social Security and Medicare tax for self-employed individuals. It contributes to your Social Security coverage. You generally must pay SE tax if net earnings are $400 or more. Statutory employees do not pay SE tax on those wages.

What About Employment Taxes?

If you have employees, you're responsible for withholding and paying Social Security, Medicare, and federal income taxes, plus federal unemployment tax (FUTA). See Pub. 15 for details.

Do I Owe Excise Taxes?

You might owe excise taxes if you manufacture/sell certain products, operate specific businesses, use certain equipment, or receive payment for certain services. Report these on forms like Form 720 or Form 2290. See Pub. 510.

What Are Information Returns?

You may need to file forms like 1099-NEC (for nonemployee compensation of $600+), 1099-MISC (for rents, royalties, prizes $600+), W-2 (for employees), or Form 8300 (for cash payments over $10,000). Penalties apply for failure to file or furnish correctly.

Chapter 2: Accounting Periods and Methods

This chapter explains how to track your income and expenses over time.

What is an Accounting Period (Tax Year)?

Once established with your first return, changing your tax year generally requires IRS approval, typically requested using Form 1128.

You must figure income for an annual period called a tax year. Most individuals use a Calendar Tax Year (Jan 1 - Dec 31), especially if they don't keep formal books. A Fiscal Tax Year is 12 months ending on the last day of any month except December. Changing your tax year generally requires IRS approval via Form 1128.

What is an Accounting Method?

• This determines when you report income and expenses. You choose a method with your first business tax return and generally need IRS approval (Form 3115) to change it.
• Cash Method: Report income when actually or constructively received. Deduct expenses when paid. Most common for individuals and service businesses without inventory. Constructive receipt means it's available to you without restriction, even if not physically possessed.
• Accrual Method: Report income when earned (all events fixing the right to receive have occurred and the amount is determinable). Deduct expenses when incurred (all-events test met and economic performance occurred). Generally required if inventory is an income-producing factor, unless you qualify as a small business taxpayer.
• Combination Method: Can use a mix (e.g., accrual for purchases/sales, cash for other items) if it clearly reflects income and is used consistently, subject to restrictions.

What About Inventories?

• If producing, purchasing, or selling merchandise is key to your income, you generally must keep inventory and use an accrual method for purchases/sales.
• Exception for Small Business Taxpayers: If average annual gross receipts are $30 million or less (for the prior 3 years) and you're not a tax shelter, you may choose not to keep inventory. Instead, you can treat inventory as non-incidental materials/supplies (deduct when used/consumed) or follow your financial accounting method.
• If keeping inventory, you must value it at the start and end of the year. Methods must conform to accepted principles and clearly reflect income. See Pub. 538.

What are Uniform Capitalization Rules (UCR)?

You must capitalize direct costs and part of indirect costs for production or resale activities. Recover these costs via depreciation, amortization, or COGS. Applies if you produce property or acquire it for resale. Small business taxpayers (see above) are generally exempt.

Chapter 3: Dispositions of Business Property

This covers what happens when you sell, exchange, or otherwise dispose of business assets.

What Counts as a Disposition?

Selling for cash/property, exchanging property, lease cancellations, transferring property to satisfy debt, abandonment, foreclosure/repossession, payments for damaged/stolen/condemned property, or giving property away.

How Do I Figure Gain or Loss?

• Gain: Amount Realized > Adjusted Basis.
• Loss: Adjusted Basis > Amount Realized.
• Basis: Usually, the cost/purchase price. Different if acquired by gift/inheritance. (See Pub. 551).
• Adjusted Basis: Original basis +/- adjustments (e.g., + improvements, - depreciation). Selling expenses add to basis.
• Amount Realized: Money received + Fair Market Value (FMV) of property/services received + buyer-assumed liabilities.

Is the Gain or Loss Ordinary or Capital?

• Disposing of a Capital Asset (most personal/investment property) results in capital gain/loss.   
• Property used in business (like inventory or depreciable property) is generally not a capital asset, yielding Ordinary Gain/Loss. However, Section 1231 rules may allow capital gain/loss treatment for business property held over a year. (See Pub. 544).

Is Capital Gain/Loss Short-Term or Long-Term?

• Depends on the Holding Period (how long you owned it).
• Short-Term: Held 1 year or less.
• Long-Term: Held more than 1 year. (See Pub. 544).

Where Do I Report Gains and Losses?

• Form 4797: Sales of business property.
• Schedule D (Form 1040): May be needed with Form 4797 for capital gains/losses.
• Form 8824: Like-kind exchanges.
• Form 6252: Installment sales.
• Form 4684: Casualties and thefts.

Chapter 4: General Business Credits

Tax credits directly reduce your tax liability. The General Business Credit (GBC) combines various individual business credits plus carryforwards/carrybacks.

What Credits Are Part of the GBC?

Many credits fall under the GBC umbrella. Some common ones (with their forms) include:

• Investment Credit (Form 3468)
• Work Opportunity Credit (Form 5884)
• Credit for Increasing Research Activities (Form 6765)
• Low-Income Housing Credit (Form 8586)
• Disabled Access Credit (Form 8826)
• Credit for Employer Social Security/Medicare Taxes on Tips (Form 8846)
• Credit for Small Employer Pension Plan Startup Costs (Form 8881)
• Credit for Small Employer Health Insurance Premiums (Form 8941)
• Clean Vehicle Credits (Form 8936)
• Energy Credits (various forms like 8911, 8864, 6478, 8933, 8908, 8835)

How Do I Claim the GBC?

• Figure individual credits on their specific forms.
• Summarize them on Form 3800, General Business Credit.

Chapter 5: Business Income

This chapter details what counts as income for your Schedule C business.

What is Business Income?

Any income connected to your business. Includes income from side jobs or the gig economy. Report amounts from Forms 1099-NEC (nonemployee compensation) and potentially Forms 1099-K (payment card/network transactions, though the reported amount may need adjustment). Income reported on Schedule C might qualify for the Qualified Business Income (QBI) deduction.

What Are Different Kinds of Income?

• Cash, Checks, Credit Card Payments: Most common forms.
• Property or Services (Bartering): Include the Fair Market Value (FMV) of what you receive in exchange for your property/services. If part of a barter exchange, you might receive Form 1099-B or 1099-MISC.
• Real Estate Rents: Report on Schedule C if you're a real estate dealer or provide significant services (like a hotel). Otherwise, use Schedule E. Includes bonuses, cancellation payments, and payments made by lessee to third parties on your behalf.
• Personal Property Rents: Income from renting equipment, vehicles, etc., is reported on Schedule C.
• Interest: Business income if from notes receivable accepted in business or if you're in the lending business.
• Dividends: Usually nonbusiness income unless you're a securities dealer or it's a recovery of previously deducted insurance premiums.
• Canceled Debt: Generally included in income, reported on Schedule C if business debt. Exceptions exist for bankruptcy, insolvency, qualified farm debt, qualified real property business debt, and certain principal residence debt. A purchase price adjustment or deductible debt may also not result in income. Use Form 982 for exclusions.
• Other Income: Include restricted property (stock/property received for services), payments for lost income, damages (patent infringement, breach of contract), kickbacks, and recoveries of previously deducted items (like bad debts).
• Recapture of Depreciation: If business use of listed property drops to 50% or less, or if Section 179 property use drops similarly, you may need to include previously deducted depreciation back into income. Use Form 4797. Gain on selling depreciable property may also be recaptured as ordinary income.

What Items Are Not Income?

• Appreciation (increase in property value before sale).
• Consigned goods (income recognized by consignor when sold).
• Construction allowances received from a landlord under specific retail lease conditions.
• Gain on exchanging like-kind business/investment real property (use Form 8824).
• Value of leasehold improvements made by a tenant (unless intended as rent).
• Bona fide loan proceeds.
• Sales tax collected for and paid over to governments.

Are There Guidelines for Specific Occupations?

Yes, Pub 334 provides guidance on whether income should be reported on Schedule C for direct sellers, executors/administrators, fishing crew members, insurance agents (former and retired ), newspaper carriers/vendors, notaries public, public officials, real estate agents, and dealers/traders in section 1256 contracts, securities, or commodities.

How Do I Account for Income?

Follow your tax year and accounting method. Income paid to a third party is still taxable to you. Account for cash discounts either by reducing purchases or crediting a discount income account. Do not book trade discounts. Escrow payments are income when constructively received. Deduct sales returns/allowances from gross sales.

Chapter 6: How To Figure Cost of Goods Sold (COGS)

If you make or buy goods to sell, COGS is a key calculation. It's generally figured in Part III of Schedule C (Lines 35-42). (Small business taxpayers may have different rules, see Chapter 2).

How is COGS Calculated?

• Line 35: Inventory at Beginning of Year: Cost of merchandise/materials on hand at the start of the year. Usually matches last year's ending inventory. Adjust for donated inventory.
• Line 36: Purchases: Cost of merchandise bought for sale or raw materials for manufacturing. Reduce by trade discounts. Account for cash discounts consistently (either reduce purchases or credit income). Subtract purchase returns/allowances. Subtract cost of items withdrawn for personal use.
• Line 37: Cost of Labor: Primarily for manufacturing/mining. Includes direct labor (working on the product) and indirect labor (necessary factory functions). Do not include payments to yourself.
• Line 38: Materials and Supplies: Costs of items used in manufacturing. Those not used in the process are deferred charges, deducted when used.
• Line 39: Other Costs: Includes integral containers/packaging, freight-in, and allocable overhead (rent, utilities, depreciation, etc.).
• Line 40: Add Lines 35-39: This equals the Cost of Goods Available for Sale.
• Line 41: Inventory at End of Year: Value of inventory on hand at year-end.
• Line 42: Cost of Goods Sold: Subtract Line 41 from Line 40.

Chapter 7: Figuring Gross Profit

Gross profit is your business income before deducting operating expenses.   

How is Gross Profit Calculated?

For businesses selling products:

• Start with Gross Receipts (Line 1).
• Subtract Returns and Allowances (Line 2) to get Net Receipts (Line 3).
• Subtract Cost of Goods Sold (Line 4) from Net Receipts (Line 3).
• The result is Gross Profit (Line 5).

For businesses selling services:

• If merchandise sales aren't an income factor, COGS is zero.
• Gross Profit equals Net Receipts.

What Should I Check?

• Ensure gross receipts records are accurate and balanced.
• Correctly handle sales tax collections.
• Verify beginning inventory matches prior year's ending inventory.
• Properly adjust purchases for personal withdrawals.
• Use adequate procedures and documentation for ending inventory counts and valuation.

How Can I Test Accuracy?

Divide Gross Profit by Net Receipts to get your gross profit percentage. Compare this to your typical markup percentage. Large differences may indicate errors in sales, purchases, or inventory figures.

What If I Have Other Income?

Add income from sources other than regular operations (like interest, scrap sales, bad debt recovery) to Gross Profit on Line 6.

Chapter 8: Business Expenses

You can deduct the ordinary and necessary costs of running your business.   

What Makes an Expense Deductible?

It must be ordinary (common in your field) and necessary (helpful and appropriate). Expenses part-business, part-personal must be allocated; only the business part is deductible.

What Are Common Deductible Expenses?

Bad Debts

Uncollectible amounts owed to you from business operations. Generally deductible only if the amount was previously included in income (accrual basis). Cash basis taxpayers usually can't deduct unpaid receivables. Use the specific charge-off method. Recoveries of previously deducted bad debts may be income.

Car and Truck Expenses

Costs of using your vehicle for business (local transport or travel away from home). Choose either the Standard Mileage Rate (70 cents/mile for 2025) plus tolls/parking, or Actual Expenses (gas, oil, repairs, insurance, depreciation, etc.). Allocate between business and personal use. Standard rate has limitations. (See Pub. 463).

Depreciation

Spreading the cost of assets lasting more than a year (equipment, buildings, but not land). Use MACRS for most property. Section 179 Deduction allows expensing a limited amount of asset cost in the year placed in service ($1,220,000 limit for 2024, subject to phase-out and vehicle limits). Special rules for listed property (cars, certain computers, entertainment property). Use Form 4562. (See Pub. 946).

Employees' Pay 

Wages, salaries, bonuses, commissions, and fringe benefits paid for services performed. They must be reasonable and for services performed. Cannot deduct your own salary as a sole proprietor.

Insurance 

Premiums for business-related coverage (fire, liability, malpractice, workers' comp, group health for employees, business use of car, etc.). Self-Employed Health Insurance Deduction: May deduct premiums for yourself and family on Schedule 1 (Form 1040). Nondeductible premiums include self-insurance reserves, policies paying for your lost earnings, and certain life insurance where you are a beneficiary.

Interest

On debts related to your business. Must be legally liable, intend to repay, and have a true debtor-creditor relationship. Allocate between business and personal use. Business interest deduction may be limited (Form 8990).

Legal and Professional Fees

Accountants' and lawyers' fees directly related to operating your business. Fees to acquire assets are added to basis. Deduct tax prep fees for the business part of your return.

Pension Plans

Deductible contributions to SEP, SIMPLE, or qualified plans for employees (on Schedule C) and for yourself (on Schedule 1, Form 1040). (See Pub. 560).

Rent Expense

For property used in your business. Cannot deduct if you have equity/title. Rent paid to related parties must be reasonable. Rent for business use of your home is deductible if qualifications are met. Deduct advance rent only for the period it applies.

Taxes

State/local taxes directly attributable to business: gross income tax (not net income tax), employer's share of employment taxes, state unemployment/disability fund payments, personal property tax on business assets, and real estate taxes on business property. One-half of SE tax is deductible on Schedule 1 (Form 1040). Sales tax is added to cost/basis. Deductible excise taxes. Fuel taxes are usually part of fuel cost.

Travel and Meals

Ordinary/necessary expenses of traveling away from home (requires sleep/rest) for business. Includes transportation, lodging, 50% of meals, cleaning, business calls, and tips. (See Pub. 463).

Business Use of Your Home

Deductible if part of your home is used exclusively and regularly as your principal place of business, a place to meet clients, or a separate structure. Principal place of business test includes administrative/management use if no other fixed location. Deduction is limited by gross income from business use. Use Form 8829 or the Simplified Method ($5/sq ft, up to 300 sq ft). (See Pub. 587).

Other Expenses

Advertising, bank fees, business association dues (not club dues), education expenses, licenses, repairs/maintenance (unless capitalized), supplies, utilities, etc.. Can elect De Minimis Safe Harbor to expense tangible property below certain thresholds ($5,000 with AFS, $2,500 without).

Also Read

• Business Expense Categories Cheat Sheet: The Top 41 Tax-Deductible Categories

What Expenses Can I NOT Deduct?

Bribes/kickbacks, charitable contributions (deduct on Sch A), demolition costs, club dues (social, athletic, etc.), entertainment, lobbying, fines/penalties for breaking the law, personal/living expenses, political contributions, payments related to sexual harassment/abuse subject to NDAs. Capital improvements (betterments, restorations, adaptations) must generally be capitalized, not expensed.

Chapter 9: Figuring Net Profit or Loss

This is the bottom line of your Schedule C.

How is Net Profit/Loss Calculated?

• Subtract total business expenses from total business income (Gross Income from Chapter 7).
• Net Profit: Income > Expenses. Reported on Schedule 1 (Form 1040).
• Net Loss: Expenses > Income. Generally deductible against other income on Schedule 1 (Form 1040).

Are There Limits on Losses?

Yes. Your loss may be limited by:

• Excess Business Loss Limitation: Noncorporate taxpayers may have a limit on the amount of business loss they can deduct in a year. Use Form 461. Disallowed loss becomes an NOL carryforward.
• Net Operating Losses (NOLs): If total deductions exceed total income for the year, you may have an NOL. NOLs can often be carried to other tax years to offset income. (See Pub. 536).
• Not-for-Profit Activities: If you don't conduct the activity with a genuine profit motive (i.e., it's a hobby), you cannot deduct losses to offset other income.

Chapter 10: Self-Employment (SE) Tax

This chapter details the Social Security and Medicare taxes for the self-employed.

Who Must Pay SE Tax?

Generally, anyone with net earnings from self-employment of $400 or more. Applies regardless of age or if receiving Social Security/Medicare benefits.

How is SE Tax Calculated?

• Rate: 15.3% (12.4% Social Security + 2.9% Medicare) on net earnings.
• Maximum Earnings (2024): The 12.4% Social Security part applies only to the first $168,600 of combined wages, tips, and net earnings. The 2.9% Medicare part applies to all combined earnings.
• Additional Medicare Tax: An extra 0.9% may apply if earnings exceed thresholds based on filing status ($250k MFJ, $125k MFS, $200k others). Use Form 8959.
• Net Earnings Calculation: Usually, net profit from Schedule C multiplied by 92.35% (0.9235). This is the Regular Method.
• Optional Methods: Can sometimes be used (if criteria met) when profit is low or there's a loss, potentially to gain Social Security credits or increase certain tax credits (like EIC). There's a Nonfarm Optional Method and a Farm Optional Method. Using optional methods can increase SE tax but may offer other benefits. Cannot use optional method to report less than actual nonfarm net earnings. The maximum reportable under combined optional methods is $6,920.

Are There Special Rules?

Rules exist for aliens, children employed by parents, certain church employees, fishing crews, notaries public (fees not subject to SE tax), certain state/local government employees, employees of foreign governments/international orgs, and citizens/residents abroad (subject to SE tax unless a social security agreement applies).

How Do I Report SE Tax?

Use Schedule SE (Form 1040). Attach to Form 1040 or 1040-SR. Even if no income tax is due, file a return with Schedule SE if SE tax is owed. Spouses file separate Schedule SEs if both have SE earnings. Combine profit/loss from multiple businesses onto one Schedule SE.

Chapter 11: Your Rights as a Taxpayer

This chapter outlines IRS processes and your rights.

• Examinations (Audits): The IRS may examine returns selected via computer programs or compliance projects. Examinations can be by mail or interview. You have the right to representation and a reasonable time/place for interviews. (See Pub. 556).
• Appeals: If you disagree with examination findings, you can appeal to the IRS's Independent Office of Appeals. If unresolved, you may go to court. (See Pub. 5, Pub. 556).
• Collections: If you owe tax, the IRS has procedures for billing and collection, including liens and levies. Options like installment agreements or Offers in Compromise may be available. (See Pub. 594, Pub. 1660). Innocent spouse relief may be available (Form 8857).
• Refunds: You can claim a refund if you overpaid. Generally, file within 3 years of filing the return or 2 years of paying the tax, whichever is later. (See Pub. 556).

Chapter 12: How To Get More Information

This chapter points to resources for help.

• IRS Resources: IRS.gov offers forms, publications, tools (Interactive Tax Assistant, Withholding Estimator, etc.), and account access. Free tax prep options include Direct File, Free File, VITA, and TCE. Taxpayer Advocate Service (TAS) provides independent help. Local Taxpayer Assistance Centers (TACs) offer in-person help by appointment.
• Other Agencies: The Small Business Administration (SBA) offers training, counseling, and resources (SBA.gov). Other federal agencies also provide assistance.

How Fyle Automates Expense Tracking for Easier Schedule C Filing

Keeping accurate records is essential for correctly filing Schedule C and maximizing your deductions. Manually tracking every receipt and categorizing expenses can be overwhelming, especially when juggling the demands of running your business. Fyle simplifies this critical task.

• Real-time Expense Tracking: Fyle captures expenses as they happen, as soon as a business credit card is swiped or via simple text message receipt submissions. This reduces missed deductions and ensures timely recording, crucial for accurate Schedule C preparation.
• Automatic Categorization: Fyle helps automatically categorize expenses according to IRS-friendly categories, making it easier to populate the different expense lines on Schedule C (like travel, meals, supplies, etc.).
• Mileage Tracking: For car and truck expenses, Fyle can automatically track business mileage, simplifying the calculation whether you use the standard mileage rate or actual expenses.
• Digital Recordkeeping: Eliminate lost paper receipts. Fyle provides digital storage, ensuring you have the necessary documentation if the IRS requests proof for deductions claimed under Pub 334 rules.
• Simplified Reporting: Generate reports easily to see your spending, which aids in completing Schedule C accurately and potentially identifying further savings.