The Challenges of Business Income
FS-2008-20, April, 2008
WASHINGTON—Internal Revenue Service
research indicates that understated business income
contributes significantly to the tax gap, with the majority
understated by small businesses.
To assist small business and self-employed
taxpayers better understand their reporting obligations,
this fact sheet addresses the issue of income and how to
determine gross income.
Business Income, Gross Receipts or Sales
If there is a connection between any
income received and a business, the income is business
income. A connection exists if it is clear that the payment
of income would not have been made if the business did not
exist and operate.
Small business owners and self-employed
taxpayers must report on their tax returns all income
received from their businesses unless specifically excluded
by law. In most cases, business income will be in the form
of cash, checks and credit card charges.
But business income can be in other forms,
such as property or services. There are many forms,
including: bartering, real estate rents, personal property rents, interest and
dividend income, canceled debt, promissory notes, lost
income payments, damages, economic injury payments, as well
as kickbacks.
All income earned is taxable. Directing
payment of income to a third party does not remove the
reporting and payment requirements for small businesses and
self-employed taxpayers.
Cost of Goods Sold
Some businesses may make or buy goods to
sell. If so, these businesses may deduct the cost of goods
sold (COGS) from their gross receipts. To determine these
costs, the value of inventory at the beginning and end of
the year must be calculated.
There are several factors that go into
determining COGS, including: inventory at the beginning of
the year; purchases less cost of items withdrawn for
personal use; labor costs (generally applies to
manufacturing and mining operations); materials and supplies
(generally a manufacturing cost); other costs (generally
applies to manufacturing and mining operations); and
inventory at the end of the year.
Inventory, net purchases, cost of labor,
materials and supplies, and other costs are added together.
Inventory at the end of the year is subtracted from this
total to determine COGS.
Gross Income
To calculate gross income, first determine
net receipts (gross receipts minus returns and allowances)
and minus the cost of goods sold. Returns and allowances
include cash or credit refunds made to customers, rebates
and other allowances off the actual sales price. Then add
any other income, including fuel tax credits. Gross income
must be determined first before deducting business expenses.
Tools to Use
There are tools available to assist small
business owners and the self-employed track and report
income such as the use of: a formal set of books and records
with strong; accounting/financial computer software; and
separate bank accounts for business and personal income and
expenses.
Small businesses and self-employed
taxpayers greatly benefit by accurately recording and
reporting all income. Insufficient recordkeeping could cause
income to be over-reported and too much tax paid or too
little income reported and too little tax paid.
The Small Business and Self-Employed
One-Stop Resource is a Web based tool. It contains a wealth
of information to educate business owners and the
self-employed on their unique tax filing and reporting
obligations.
Another Web based tool is the Online
Learning and Educational Products section of IRS.gov which
allows business owners to view a streaming video of an IRS
Small Business Workshop, order the Small Business Workshop
on DVD, take an IRS course, or complete an online,
self-directed version of a workshop taught live around the
country.
These tools can help to more accurately
determine income and expenses as well. There are benefits
beyond accurate income and expense reporting to be gained.
Formalized financial records will help small businesses when
it is time to apply for loans or efforts to obtain capital
for expansion.
Links:
Publication 334, Tax Guide for Small Business
·
Publication 583, Starting a Business and Keeping
Records
·
|
