18.1 Schedule C Overview
Key Takeaways
- Schedule C reports profit/loss from a sole proprietorship or single-member LLC.
- Trade or business requires continuity, regularity, and profit motive.
- IRS uses Control Test (behavioral, financial, relationship) for worker classification.
- Small business taxpayers (under $31M gross receipts in 2025) can use cash method.
- Statutory employees report W-2 income on Schedule C but no SE tax.
- Employee vs. Contractor classification has significant tax consequences.
Why This Matters for the Exam
Schedule C is central to Part 2. The exam tests who files Schedule C, the employee vs. contractor distinction, and small business accounting rules.
Exam Note: For the July 1, 2026 - February 28, 2027 testing window, you are tested on sole proprietorship rules as of December 31, 2025 (Tax Year 2025), reflecting all changes made by the One Big Beautiful Bill Act (OBBBA) signed July 4, 2025.
Expect at least 3-4 questions on Schedule C basics.
Who Files Schedule C?
| Entity Type | File Schedule C? |
|---|---|
| Sole proprietor | Yes |
| Single-member LLC (default) | Yes (disregarded entity) |
| Independent contractor | Yes |
| Statutory employee | Yes (but no SE tax) |
| Partner in partnership | No (K-1 to Schedule E) |
| S corp shareholder | No (K-1 to Schedule E) |
Trade or Business Standard
To file Schedule C, the activity must be a "trade or business":
| Requirement | Description |
|---|---|
| Continuity | Ongoing activity |
| Regularity | Consistent effort |
| Profit motive | Primary purpose is income |
Employee vs. Independent Contractor
This is a high-yield exam topic. Classification determines who pays FICA and where expenses are deducted.
| Factor | Employee | Independent Contractor |
|---|---|---|
| Reporting form | W-2 | 1099-NEC |
| FICA taxes | Employer withholds | Self-employment tax |
| Expense deduction | Generally none | Schedule C |
| Control | Employer controls | Worker controls |
The Control Test (Three Categories)
| Category | Key Questions |
|---|---|
| Behavioral | Does company control when, where, how work is done? |
| Financial | Does worker have unreimbursed expenses? Significant investment? Profit/loss potential? |
| Relationship | Written contract? Employee benefits? Permanency? |
Statutory Employees
| Feature | Rule |
|---|---|
| W-2 Box 13 | "Statutory Employee" checked |
| Income reporting | Schedule C (not Schedule E) |
| Expenses | Deductible on Schedule C |
| SE tax | NO (FICA already withheld) |
Examples: Full-time life insurance agents, certain drivers, traveling salespeople.
Small Business Taxpayer Rules (Tax Year 2025)
Taxpayers with average gross receipts ≤ $31 million (3-year average; inflation-adjusted from $30M in 2024) qualify for simplifications:
| Simplification | Benefit |
|---|---|
| Cash method | Even with inventory |
| Inventory exception | Treat as non-incidental materials |
| §263A exemption | No UNICAP required |
Inventory for Small Taxpayers
| Method | Description |
|---|---|
| Non-incidental materials | Deduct when provided to customer OR paid, whichever later |
| Financial accounting | Follow book treatment |
| Benefit | No LIFO/FIFO required for tax |
NEW OBBBA Above-the-Line Deductions for 2025 Sole Proprietors
OBBBA introduced four new temporary above-the-line deductions (2025-2028) that affect many self-employed individuals:
| Deduction | 2025 Cap | Notes |
|---|---|---|
| Tip Income ("No Tax on Tips") | $25,000 | Qualified occupations (Treasury list); MAGI phase-out $150K/$300K |
| Overtime Premium | $12,500 / $25,000 MFJ | FLSA-required premium only; same phase-out |
| Auto Loan Interest | $10,000 | New US-assembled vehicle, personal use, loan originated 2025-2028 |
| Senior Bonus | $6,000 per qualifying 65+ filer | Phase-out MAGI $75K/$150K |
These are deductions, not exclusions — tips and overtime are still reported as Schedule C / W-2 income and are still subject to SE tax. The deduction is taken on Schedule 1.
Real-World Scenario
Scenario: A graphic designer works from home, sets their own hours, uses their own computer, and has 10 clients. They receive 1099-NEC forms totaling $80,000 in 2025.
- Classification: Independent contractor (controls work, owns tools, multiple clients).
- Reporting: Schedule C.
- SE Tax: Yes, self-employment tax applies.
- Expenses: Deductible on Schedule C.
On the Exam
Expect 3-4 questions on Schedule C basics, typically:
- Filing Questions: "Who files Schedule C?"
- Classification Questions: "Employee or contractor based on these facts?"
- Statutory Employee Questions: "How are statutory employees taxed?"
- Accounting Questions: "What is the gross receipts threshold for cash method?"
The key is to remember: Sole proprietor/SMLLC = Schedule C. Control test determines classification. Statutory employees = Schedule C income, no SE tax. Small business ($31M in 2025) can use cash method.
Which taxpayer would file Schedule C?
Worker is given tools by company, works specific hours, and receives health insurance. Classification?
What is the Tax Year 2025 gross receipts threshold for cash method (small business taxpayer)?