p334 tax guide for small business

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Departmentof theTreasury

Internal

RevenueService

Get forms and other information faster and easier by:Internet IRS.gov

Tax Guide forSmall Business(For Individuals Who UseSchedule C or C-EZ)

Publication 334

Catalog Number 11063P

For use in preparin

2012 Returns

Dec 03, 2012
http://www.irs.gov/


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Contents

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Future Developments . . . . . . . . . . . . . . . . . . . . . . . . . . 4

What's New for 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

What's New for 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Reminders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Photographs of Missing Children . . . . . . . . . . . . . . . . . . . 4

Chapter 1. Filing and Paying Business Taxes . . . . . . . . . . . 5

Identification Numbers . . . . . . . . . . . . . . . . . . . . . . 5

Income Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Self-Employment (SE) Tax . . . . . . . . . . . . . . . . . . . . 8

Employment Taxes . . . . . . . . . . . . . . . . . . . . . . . . . 9

Excise Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Information Returns . . . . . . . . . . . . . . . . . . . . . . . 10

Chapter 2. Accounting Periods and Methods . . . . . . . . . . 11

Accounting Periods . . . . . . . . . . . . . . . . . . . . . . . 11

Accounting Methods . . . . . . . . . . . . . . . . . . . . . . . 12

Chapter 3. Dispositions of Business Property . . . . . . . . . 16

What Is a Disposition of Property? . . . . . . . . . . . . . . 16

How Do I Figure a Gain or Loss? . . . . . . . . . . . . . . . 17

Where Do I Report Gains and Losses? . . . . . . . . . . . . 17

Chapter 4. General Business Credits . . . . . . . . . . . . . . . 18

Business Credits . . . . . . . . . . . . . . . . . . . . . . . . . 18

How To Claim the Credit . . . . . . . . . . . . . . . . . . . . 19

Chapter 5. Business Income . . . . . . . . . . . . . . . . . . . . 19

Kinds of Income . . . . . . . . . . . . . . . . . . . . . . . . . 19

Items That Are Not Income . . . . . . . . . . . . . . . . . . . 23

Guidelines for Selected Occupations . . . . . . . . . . . . 24Accounting for Your Income . . . . . . . . . . . . . . . . . . 26

Chapter 6. How To Figure Cost of Goods Sold . . . . . . . . . 26

Figuring Cost of Goods Sold on Schedule C, Lines

35 Through 42 . . . . . . . . . . . . . . . . . . . . . . . . . 27

Chapter 7. Figuring Gross Profit . . . . . . . . . . . . . . . . . . 28

Items To Check . . . . . . . . . . . . . . . . . . . . . . . . . . 29

Testing Gross Profit Accuracy . . . . . . . . . . . . . . . . . 29

Additions to Gross Profit . . . . . . . . . . . . . . . . . . . . 30

Chapter 8. Business Expenses . . . . . . . . . . . . . . . . . . . 30

Bad Debts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

Car and Truck Expenses . . . . . . . . . . . . . . . . . . . . 30Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

Employees' Pay . . . . . . . . . . . . . . . . . . . . . . . . . . 33

Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34

Legal and Professional Fees . . . . . . . . . . . . . . . . . . 35

Pension Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

Rent Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

Travel, Meals, and Entertainment . . . . . . . . . . . . . . . 36

Business Use of Your Home . . . . . . . . . . . . . . . . . . 37

Other Expenses You Can Deduct . . . . . . . . . . . . . . . 38

Expenses You Cannot Deduct . . . . . . . . . . . . . . . . . 39

Chapter 9. Figuring Net Profit or Loss . . . . . . . . . . . . . . 39

Net Operating Losses (NOLs) . . . . . . . . . . . . . . . . . 39

Not-for-Profit Activities . . . . . . . . . . . . . . . . . . . . . 39

Chapter 10. Self-Employment (SE) Tax . . . . . . . . . . . . . . 40

Who Must Pay SE Tax? . . . . . . . . . . . . . . . . . . . . . 40

Reporting Self-Employment Tax . . . . . . . . . . . . . . . . 44

Chapter 11. Your Rights as a Taxpayer . . . . . . . . . . . . . . 44

Declaration of Taxpayer Rights . . . . . . . . . . . . . . . . 44

Examinations, Appeals, Collections, and Refunds . . . . 45

Chapter 12. How To Get More Information . . . . . . . . . . . . 46

Internal Revenue Service . . . . . . . . . . . . . . . . . . . . 46

Small Business Administration . . . . . . . . . . . . . . . . 48

Other Federal Agencies . . . . . . . . . . . . . . . . . . . . . 48

Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

IntroductionThe purpose of this publication is to provide general infor-

mation about the federal tax laws that apply to small busi-ness owners who are sole proprietors and to statutory em-ployees. This publication has information on businessincome, expenses, and tax credits that may help you fileyour income tax return.

Are you self-employed? You are self-employed if youcarry on a trade or business as a sole proprietor or an in-dependent contractor.

Sole proprietor. A sole proprietor is someone who ownsan unincorporated business by himself or herself. How-ever, if you are the sole member of a domestic limited lia-bility company (LLC), you are not a sole proprietor if youelect to treat the LLC as a corporation.

Trade or business. A trade or business is generally anactivity carried on to make a profit. The facts and circum-stances of each case determine whether or not an activityis a trade or business. You do not need to actually make aprofit to be in a trade or business as long as you have aprofit motive. You do need to make ongoing efforts to fur-ther the interests of your business.

You do not have to carry on regular full-time businessactivities to be self-employed. Having a part-time busi-ness in addition to your regular job or business may beself-employment.

Independent contractor. People such as doctors, den-tists, veterinarians, lawyers, accountants, contractors,subcontractors, public stenographers, or auctioneers whoare in an independent trade, business, or profession inwhich they offer their services to the general public aregenerally independent contractors. However, whetherthey are independent contractors or employees dependson the facts in each case. The general rule is that an indi-vidual is an independent contractor if the payer has theright to control or to direct only the result of the work and

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not how it will be done. The earnings of a person who isworking as an independent contractor are subject toself-employment tax. For more information on determiningwhether you are an employee or independent contractor,see Publication 15-A, Employer's Supplemental TaxGuide.

Statutory employee. A statutory employee has a check-mark in box 13 of his or her Form W-2, Wage and TaxStatement. Statutory employees use Schedule C or C-EZto report their wages and expenses.

Limited liability company (LLC). A limited liability com-pany (LLC) is an entity formed under state law by filing ar-ticles of organization. Generally, a single-member LLC isdisregarded as an entity separate from its owner and re-ports its income and deductions on its owner's federal in-come tax return. An owner who is an individual may useSchedule C or C-EZ.

Husband and wife business. If you and your spousejointly own and operate an unincorporated business andshare in the profits and losses, you are partners in a part-nership, whether or not you have a formal partnershipagreement. Do not use Schedule C or C-EZ. Instead, fileForm 1065, U.S. Return of Partnership Income. For moreinformation, see Publication 541, Partnerships.

ExceptionCommunity income. If you and yourspouse wholly own an unincorporated business as com-munity property under the community property laws of astate, foreign country, or U.S. possession, you can treatthe business either as a sole proprietorship or a partner-ship. The only states with community property laws areArizona, California, Idaho, Louisiana, Nevada, New Mex-ico, Texas, Washington, and Wisconsin. A change in yourreporting position will be treated as a conversion of theentity.

ExceptionQualified joint venture. If you and yourspouse each materially participate as the only members ofa jointly owned and operated business, and you file a jointreturn for the tax year, you can make a joint election to betreated as a qualified joint venture instead of a partnershipfor the tax year. Making this election will allow you to avoidthe complexity of Form 1065 but still give each spousecredit for social security earnings on which retirementbenefits are based. For an explanation of "material partici-pation," see the Instructions for Schedule C, line G.

To make this election, you must divide all items of in-come, gain, loss, deduction, and credit attributable to thebusiness between you and your spouse in accordance

with your respective interests in the venture. Each of youmust file a separate Schedule C or C-EZ and a separateSchedule SE. For more information, see Qualified JointVenture in the Instructions for Schedule SE.

This publication does not cover the topics listed inthe following table.

IF you need information about: THEN you should see:

Corporations . . . . . . . . . . . . . . . . . . . Publication 542Farming . . . . . . . . . . . . . . . . . . . . . . . Publication 225

Fishermen (Capital Construction Fund) . . . Publication 595

Partnerships . . . . . . . . . . . . . . . . . . . . Publication 541Passive activities . . . . . . . . . . . . . . . . . Publication 925

Recordkeeping . . . . . . . . . . . . . . . . . . Publication 583Rental . . . . . . . . . . . . . . . . . . . . . . . . Publication 527S corporations . . . . . . . . . . . . . . . . . . . Instructions for Form

1120S

What you need to know. Table A provides a list ofquestions you need to answer to help you meet your fed-eral tax obligations. After each question is the location inthis publication where you will find the related discussion.

What You Need To Know About Federal Taxes

(Note. The following is a list of questions you may need to answer so you can fill out your federal income tax return.Chapters are given to help you find the related discussion in this publication.)

What must I know Where to find the answer

What kinds of federal taxes do I have to pay? How do I pay them? See chapter 1.

What forms must I file? See chapter 1.

What must I do if I have employees? See Employment Taxes in chapter 1.

Do I have to start my tax year in January, or can I start it in any other month? SeeAccounting Periods in chapter 2.What method can I use to account for my income and expenses? SeeAccounting Methods in chapter 2.

What kinds of business income do I have to report on my tax return? See chapter 5.

What kinds of business expenses can I deduct on my tax return? See Business Expenses in chapter 8.

What kinds of expenses are not deductible as business expenses? See Expenses You Cannot Deductin chapter 8.

What happens if I have a business loss? Can I deduct it? See chapter 9.

What must I do if I disposed of business property during the year? See chapter 3.

What are my rights as a taxpayer? See chapter 11.

Where do I go if I need help with federal tax matters? See chapter 12.

Table A.

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IRS mission. Provide America's taxpayers top qualityservice by helping them understand and meet their tax re-sponsibilities and by applying the tax law with integrity andfairness to all.

Comments and suggestions. We welcome your com-ments about this publication and your suggestions for fu-ture editions.

You can write to us at the following address:

Internal Revenue ServiceBusiness Forms and Publications BranchSE:W:CAR:MP:T:B1111 Constitution Ave. NW, IR-6526Washington, DC 20224

We respond to many letters by telephone. Therefore, itwould be helpful if you would include your daytime phonenumber, including the area code, in your correspondence.

You can email us at [email protected]. Please putPublications Comment on the subject line. You can alsosend us comments from www.irs.gov/formspubs, selectComment on Tax Forms and Publications under MoreInformation.

Although we cannot respond individually to each com-ment received, we do appreciate your feedback and willconsider your comments as we revise our tax products.

Ordering forms and publications. Visitwww.irs.gov/formspubs to download forms and publica-tions, call 1-800-829-3676, or write to the address belowand receive a response within 10 days after your requestis received.

Internal Revenue Service1201 N. Mitsubishi MotorwayBloomington, IL 61705-6613

Tax questions. If you have a tax question, check theinformation available on IRS.gov or call 1-800-TAX-FORM(1-800-829-1040). We cannot answer tax questions sentto either of the above addresses.

Future DevelopmentsFor the latest information about developments related toPublication 334, such as legislation enacted after it waspublished, go to www.irs.gov/pub334.

What's New for 2012The following are some of the tax changes for 2012. Forinformation on other changes, go to IRS.gov.

Tax rates. For tax years beginning in 2012, the socialsecurity part of the self-employment tax remains at 10.4%.The Medicare part of the tax remains at 2.9%. As a result,the self-employment tax is 13.3%.

Maximum net earnings. The maximum net self-employ-ment earnings subject to the social security part of theself-employment tax increases to $110,100 for 2012.

There is no maximum limit on earnings subject to theMedicare part.

Standard mileage rate. For 2012, the standard mileagerate for the cost of operating your car, van, pickup, orpanel truck for each mile of business use is 55.5 cents permile.

For more information, see Car and Truck Expenses inchapter 8.

What's New for 2013The following are some of the tax changes for 2013. Forinformation on other changes, go to IRS.gov.

Standard mileage rate. For 2013, the standard mileagerate for the cost of operating your car, van, pickup, orpanel truck for each mile of business use is 56.5 cents permile.

Self-employment tax The maximum net self-employ-ment earnings subject to the social security part of theself-employment tax is $113,700 for 2013.

RemindersAccounting methods. Certain small business taxpayersmay be eligible to adopt or change to the cash method ofaccounting and may not be required to account for inven-tories. For more information, see Inventories in chapter 2.

Reportable transactions. You must file Form 8886, Re-portable Transaction Disclosure Statement, to report cer-tain transactions. You may have to pay a penalty if you arerequired to file Form 8886 but do not do so. You may alsohave to pay interest and penalties on any reportable trans-action understatements. Reportable transactions include:

1. Transactions the same as or substantially similar to

tax avoidance transactions identified by the IRS,

2. Transactions offered to you under conditions of confi-dentiality for which you paid an advisor a minimumfee,

3. Transactions for which you have, or a related partyhas, contractual protection against disallowance ofthe tax benefits,

4. Transactions that result in losses of at least $2 millionin any single tax year ($50,000 if from certain foreigncurrency transactions) or $4 million in any combina-tion of tax years, and

5. Transactions the same or substantially similar to oneof the types of transactions the IRS has identified as atransaction of interest.

For more information, see the Instructions for Form 8886.

Photographs of MissingChildrenThe Internal Revenue Service is a proud partner with theNational Center for Missing and Exploited Children.

Page 4 Publication 334 (2012)
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Photographs of missing children selected by the Centermay appear in this publication on pages that wouldotherwise be blank. You can help bring these childrenhome by looking at the photographs and calling1-800-THE-LOST (1-800-843-5678) if you recognize achild.

1.

Filing and Paying

Business Taxes

IntroductionThis chapter explains the business taxes you may have topay and the forms you may have to file. It also discussestaxpayer identification numbers.

Table 1-1 lists the benefits of filing electronically.Table 1-2 lists the federal taxes you may have to pay,

their due dates, and the forms you use to report them.Table 1-3 provides checklists that highlight the typical

forms and schedules you may need to file if you ever goout of business.

You may want to get Publication 509, Tax Calen-dars. It has tax calendars that tell you when to filereturns and make tax payments.

Useful ItemsYou may want to see:

Publication

Tax Withholding and Estimated Tax

Form (and Instructions)

U.S. Individual Income Tax Return

Estimated Tax for Individuals

Profit or Loss From Business

Net Profit From Business

Self-Employment Tax

See chapter 12 for information about getting publicationsand forms.

Identification NumbersThis section explains three types of taxpayer identificationnumbers, who needs them, when to use them, and how toget them.

Social security number (SSN). Generally, use yourSSN as your taxpayer identification number. You must put

TIP

505

1040

1040-ES

Sch C (Form 1040)

Sch C-EZ (Form 1040)

Sch SE (Form 1040)

this number on each of your individual income tax forms,such as Form 1040 and its schedules.

To apply for an SSN, use Form SS-5, Application for aSocial Security Card. This form is available at Social Se-curity Administration (SSA) offices or by calling1-800-772-1213. It is also available from the SSA websiteat www.socialsecurity.gov.

Individual taxpayer identification number (ITIN). TheIRS will issue an ITIN if you are a nonresident or resident

alien and you do not have and are not eligible to get anSSN. In general, if you need to obtain an ITIN, you mustattach Form W-7, Application for IRS Individual TaxpayerIdentification Number, with your signed, original, comple-ted tax return and any other required documentation andmail them to the following address.

Internal Revenue ServiceITIN OperationP.O. Box 149342Austin, TX 78714-9342

The exceptions are covered in detail in the instructions forForm W-7. If you must include another person's SSN onyour return and that person does not have and cannot getan SSN, enter that person's ITIN. The application is alsoavailable in Spanish. The form is available at IRS.gov oryou can call 1-800-829-3676 to order the form.

An ITIN is for tax use only. It does not entitle theholder to social security benefits or change theholder's employment or immigration status.

Employer identification number (EIN). You must alsohave an EIN to use as a taxpayer identification number ifyou do either of the following.

Pay wages to one or more employees.

File pension or excise tax returns.

If you must have an EIN, include it along with your SSNon your Schedule C or C-EZ.

You can apply for an EIN:

Online by clicking on the EIN link atwww.irs.gov/businesses/small. The EIN is issued im-mediately once the application information is valida-ted.

By telephone at 1-800-829-4933 from 7:00 a.m. to7:00 p.m. in your local time zone.

By mailing or faxing Form SS-4, Application for Em-ployer Identification Number.

New EIN. You may need to get a new EIN if either theform or the ownership of your business changes. Formore information, see Publication 1635, UnderstandingYour EIN.

When you need identification numbers of other per-sons. In operating your business, you will probably makecertain payments you must report on information returns.These payments are discussed under InformationReturns, later in this chapter. You must give the recipient

CAUTION

!

Chapter 1 Filing and Paying Business Taxes Page 5
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of these payments (the payee) a statement showing thetotal amount paid during the year. You must include thepayee's identification number and your identification num-ber on the returns and statements.

Employee. If you have employees, you must get anSSN from each of them. Record the name and SSN ofeach employee exactly as they are shown on the employ-ee's social security card. If the employee's name is notcorrect as shown on the card, the employee should re-

quest a new card from the SSA. This may occur if the em-ployee's name was changed due to marriage or divorce.Form W-4, Employee's Withholding Allowance Certifi-

cate, is completed by each employee so the correct fed-eral income tax can be withheld from their pay.

If your employee does not have an SSN, he or sheshould file Form SS-5 with the SSA.

Other payee. If you make payments to someone whois not your employee and you must report the paymentson an information return, get that person's SSN. If youmust report payments to an organization, such as a corpo-ration or partnership, you must get its EIN.

To get the payee's SSN or EIN, use Form W-9, Re-

quest for Taxpayer Identification Number and Certifica-tion.

A payee who does not provide you with an identifica-tion number may be subject to backup withholding. For in-formation on backup withholding, see the Form W-9 in-structions and the General Instructions for CertainInformation Returns.

Income TaxThis part explains whether you have to file an income taxreturn and when you file it. It also explains how you paythe tax.

Do I Have To Filean Income Tax Return?

You have to file an income tax return for 2012 if your netearnings from self-employment were $400 or more. If yournet earnings from self-employment were less than $400,you still have to file an income tax return if you meet anyother filing requirement listed in the Form 1040 instruc-tions.

How Do I File?

File your income tax return on Form 1040 and attachSchedule Cor Schedule C-EZ. Enter the net profit or lossfrom Schedule C or Schedule C-EZ on page 1 of Form1040. Use Schedule C to figure your net profit or loss fromyour business. If you operated more than one business asa sole proprietorship, you must attach a separate Sched-ule C for each business. You can use the simpler Sched-ule C-EZ if you operated only one business as a sole pro-prietorship, you did not have a net loss, and you meet theother requirements listed in Part I of the schedule.

IRS e-file (Electronic Filing)

You may be able to file your tax returns electronicallyusing an IRS e-file option. Table 1-1 lists the benefits ofIRS e-file. IRS e-file uses automation to replace most ofthe manual steps needed to process paper returns. As a

result, the processing of e-file returns is faster and moreaccurate than the processing of paper returns. As with apaper return, you are responsible for making sure your re-turn contains accurate information and is filed on time.

Using e-file does not affect your chances of an IRS ex-amination of your return.

You can file most commonly used business forms usingIRS e-file. For more information, visit IRS.gov.

Electronic signatures. Paperless filing is easier thanyou think and it's available to most taxpayers who fileelectronicallyincluding those first-time filers who were16 or older at the end of 2012. If you file electronically us-ing tax preparation software or a tax professional, you willparticipate in the Self-Select PIN (personal identificationnumber) program. If you are married filing jointly, you andyour spouse will each need to create a PIN and enterthese PINs as your electronic signatures.

To create a PIN, you must know your adjusted gross in-come (AGI) from your originally filed 2011 income tax re-turn (not from an amended return, Form 1040X, or anymath error notice from the IRS). You will also need to pro-vide your date of birth (DOB). Make sure your DOB is ac-curate and matches the information on record with the So-cial Security Administration before you e-file. To do this,check your annual Social Security Statement.

With a Self-Select PIN, there is nothing to sign andnothing to mailnot even your Forms W-2. For more de-tails on the Self-Select PIN program, visit IRS.gov.

State returns. In most states, you can file an electronicstate return simultaneously with your federal return. Formore information, check with your local IRS office, statetax agency, tax professional, or IRS.gov.

Refunds. You can have your refund check mailed to you,or you can have your refund deposited directly to yourchecking or savings account.

With e-file, your refund will be issued in half the time aswhen filing on paper. Most refunds are issued within 3weeks. If you choose Direct Deposit, you can receive yourrefund in as few as 10 days.

Offset against debts. As with a paper return, youmay not get all of your refund if you owe certain past-dueamounts, such as federal tax, state tax, a student loan, orchild support. You will be notified if the refund you claimedhas been offset against your debts.

Refund inquiries. You can check the status of your re-fund if it has been at least 3 weeks from the date you filedyour return. Be sure to have a copy of your tax return

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available because you will need to know the filing status,the first social security number shown on the return, andthe exact whole-dollar amount of the refund. To check onyour refund, do one of the following.

Go to IRS.gov and click on Where's My Refund.

Call 1-800-829-4477 for automated refund informa-tion, and follow the recorded instructions.

Call 1-800-829-1954 during the hours shown in your

form instructions.Balance due. If you owe tax, you must pay it by April 15,2013, to avoid late-payment penalties and interest. Youcan make your payment electronically by scheduling anelectronic funds withdrawal from your checking or savingsaccount or by credit card.

Using an Authorized IRS e-file Provider

Many tax professionals can electronically file paperlessreturns for their clients. You have two options.

1. You can prepare your return, take it to an authorized

IRS e-file provider, and have the provider transmit itelectronically to the IRS.

2. You can have an authorized IRS e-file provider pre-pare your return and transmit it for you electronically.

You will be asked to complete Form 8879, IRS e-fileSignature Authorization, to authorize the provider to enteryour self-selected PIN on your return.

Depending on the provider and the specific services re-quested, a fee may be charged. To find an authorized IRSe-file provider near you, go to IRS.gov or look for an Au-thorized IRS e-file Provider sign.

Using Your Personal Computer

A computer with Internet access is all you need to file yourtax return using IRS e-file. When you use your personalcomputer, you can e-file your return from your home anytime of the day or night. Sign your return electronically us-ing a self-selected PIN to complete the process. There isno signature form to submit or Forms W-2 to send in.

Free Internet filing options. More taxpayers can nowprepare and e-file their individual income tax returns freeusing commercial tax preparation software accessiblethrough IRS.gov or www.usa.gov. The IRS is partneringwith the tax software industry to offer free preparation andfiling services to a significant number of taxpayers. Secur-ity and privacy certificate programs will assure tax data issafe and secure. To see if you qualify for these services,visit the Free Internet Filing Homepage at IRS.gov.

If you cannot use the free services, you can buy tax

preparation software at various electronics stores or com-puter and office supply stores. You can also downloadsoftware from the Internet or prepare and file your returncompletely online by using tax preparation software avail-able on the Internet.

Filing Through Employers and FinancialInstitutions

Some businesses offer free e-file to their employees,members, or customers. Others offer it for a fee. Ask youremployer or financial institution if they offer IRS e-file asan employee, member, or customer benefit.

Free Help With Your Return

Free help in preparing your return is available nationwidefrom IRS-trained volunteers. The Volunteer Income TaxAssistance (VITA) program is designed to help low-in-come taxpayers, and the Tax Counseling for the Elderly(TCE) program is designed to assist taxpayers age 60 orolder with their tax returns. Some locations offer free elec-tronic filing.

When Is My Tax Return Due?

Form 1040 for calendar year 2012 is due by April 15,2013. If you use a fiscal year (explained in chapter 2),your return is due by the 15th day of the 4th month afterthe end of your fiscal year. If you file late, you may have topay penalties and interest.

If you cannot file your return on time, use Form 4868,Application for Automatic Extension of Time To File U.S.Individual Income Tax Return, to request an automatic6-month extension. For calendar year taxpayers, this willextend the tax filing due date until October 15. Filing an

Table 1-1. Benefits of IRS e-file

Accuracy Your chance of getting an error notice from the IRS is significantly reduced.

Security Your privacy and security are assured.Electronic signatures Create your own personal identification number (PIN) and file a completely paperless return through your

tax preparation software or tax professional. There is nothing to mail.

Proof of acceptance You receive an electronic acknowledgment within 48 hours that the IRS has accepted your return forprocessing.

Fast refunds You get your refund faster with Direct Depositin as few as 10 days.

Free Internet filing options Use IRS.gov to access commercial tax preparation and e-file services available at no cost to eligible

taxpayers.

Electronic payment options Convenient, safe, and secure electronic payment options are available. E-file and pay your taxes in a

single step. Schedule an electronic funds withdrawal from your checking or savings account (up to andincluding April 15, 2013) or pay by credit card.

Federal/State filing Prepare and file your federal and state tax returns together and double the benefits you get from e-file.

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extension does not extend the time to pay your taxes, onlythe time to file the tax return.

How Do I Pay Income Tax?

Federal income tax is a pay-as-you-go tax. You must payit as you earn or receive income during the year. An em-ployee usually has income tax withheld from his or herpay. If you do not pay your tax through withholding, or donot pay enough tax that way, you might have to pay esti-

mated tax. You generally have to make estimated tax pay-ments if you expect to owe taxes, including self-employ-ment tax (discussed later), of $1,000 or more when youfile your return. Use Form 1040-ES to figure and pay thetax. If you do not have to make estimated tax payments,you can pay any tax due when you file your return. Formore information on estimated tax, see Publication 505,Tax Withholding and Estimated Tax.

What are my payment options? You can pay your esti-mated tax electronically using various options. If you payelectronically, there is no need to mail in Form 1040-ESpayment vouchers. These options include:

1. Paying electronically through the Electronic FederalTax Payment System (EFTPS).

2. Paying by authorizing an electronic funds withdrawalwhen you file Form 1040 electronically.

3. Paying by credit or debit card over the phone or by In-ternet.

Other options include crediting an overpayment from your2012 return to your 2013 estimated tax, or mailing a checkor money order with a Form 1040-ES payment voucher.

EFTPS

1. To enroll in EFTPS, go to www.eftps.govor call1-800-555-4477.

2. When you request a new EIN and you will have a taxobligation, you are automatically enrolled in EFTPS.

3. Benefits of EFTPS:

a. The chance of an error in making your paymentsis reduced.

b. You receive immediate confirmation of everytransaction.

Penalty for underpayment of tax. If you did not payenough income tax and self-employment tax for 2012 bywithholding or by making estimated tax payments, youmay have to pay a penalty on the amount not paid. TheIRS will figure the penalty for you and send you a bill. Oryou can use Form 2210, Underpayment of Estimated Taxby Individuals, Estates, and Trusts, to see if you have topay a penalty and to figure the penalty amount. For moreinformation, see Publication 505.

Self-Employment (SE) TaxSelf-employment tax (SE tax) is a social security andMedicare tax primarily for individuals who work for them-selves. It is similar to the social security and Medicaretaxes withheld from the pay of most wage earners.

If you earned income as a statutory employee,you do not pay SE tax on that income.

Social security coverage. Social security benefits areavailable to self-employed persons just as they are towage earners. Your payments of SE tax contribute to yourcoverage under the social security system. Social securitycoverage provides you with retirement benefits, disabilitybenefits, survivor benefits, and hospital insurance (Medi-care) benefits.

By not reporting all of your self-employment in-come, you could cause your social security bene-fits to be lower when you retire.

How to become insured under social security. You

must be insured under the social security system beforeyou begin receiving social security benefits. You are in-sured if you have the required number of credits (alsocalled quarters of coverage), discussed next.

Earning credits in 2012 and 2013. For 2012, you re-ceived one credit, up to a maximum of four credits, foreach $1,130 ($1,160 for 2013) of income subject to socialsecurity taxes. Therefore, for 2012, if you had income(self-employment and wages) of $4,520 that was subjectto social security taxes, you receive four credits ($4,520 $1,130).

For an explanation of the number of credits you musthave to be insured and the benefits available to you andyour family under the social security program, consult yournearest Social Security Administration (SSA) office.

Making false statements to get or to increase so-cial security benefits may subject you to penal-ties.

The Social Security Administration (SSA) time limitfor posting self-employment income. Generally, theSSA will give you credit only for self-employment incomereported on a tax return filed within 3 years, 3 months, and15 days after the tax year you earned the income. If youfile your tax return or report a change in your self-employ-

ment income after this time limit, the SSA may change itsrecords, but only to remove or reduce the amount. TheSSA will not change its records to increase your self-em-ployment income.

Who must pay self-employment tax. You must pay SEtax and file Schedule SE (Form 1040) if either of the fol-lowing applies.

1. Your net earnings from self-employment (excludingchurch employee income) were $400 or more.

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2. You had church employee income of $108.28 ormore.

The SE tax rules apply no matter how old you areand even if you are already receiving social se-curity or Medicare benefits.

SE tax rate. For 2012, the SE tax rate on net earnings is13.3% (10.4% social security tax plus 2.9% Medicare tax).

Maximum earnings subject to SE tax. Only the first$110,100 of your combined wages, tips, and net earningsin 2012 is subject to any combination of the 10.4% socialsecurity part of SE tax, social security tax, or railroad re-tirement (tier 1) tax.

All your combined wages, tips, and net earnings in2012 are subject to any combination of the 2.9% Medicare

part of SE tax, social security tax, or railroad retirement(tier 1) tax.

If wages and tips you receive as an employee are sub-ject to either social security or railroad retirement (tier 1)tax, or both, and total at least $110,100, do not pay the10.4% social security part of the SE tax on any of your netearnings. However, you must pay the 2.9% Medicare partof the SE tax on all your net earnings.

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Deduct the employer-equivalent portion of yourSE tax as an adjustment to income on line 27 ofForm 1040.

More information. For information on methods of calcu-lating SE tax, see Chapter 10, Self-Employment Tax.

Employment TaxesIf you have employees, you will need to file forms to reportemployment taxes. Employment taxes include the follow-ing items.

Social security and Medicare taxes.

Federal income tax withholding.Federal unemployment (FUTA) tax.

For more information, see Publication 15 (Circular E), Em-ployer's Tax Guide. That publication explains your tax re-sponsibilities as an employer.

To help you determine whether the people working foryou are your employees, see Publication 15-A, Employ-er's Supplemental Tax Guide. That publication has infor-mation to help you determine whether an individual is anindependent contractor or an employee.

TIP

Table 1-2. Which Forms Must I File?

IF you are liable for: THEN use Form: DUE by:1

Income tax 1040 and Schedule C or C-EZ2 15th day of 4th month after end of

tax year.

Self-employment tax Schedule SE File with Form 1040.

Estimated tax 1040-ES 15th day of 4th, 6th, and 9th months of tax

year, and 15th day of 1st month after the endof tax year.

Social security and Medicare taxes and incometax withholding

941 or 944 April 30, July 31, October 31, and January 313

.

See Publication 15.

Providing information on social security andMedicare taxes and income tax withholding

W-2 (to employee)

W-2 and W-3 (to the Social Security

Administration)

January 313.

Last day of February (March 31 if filing

electronically)3.

Federal unemployment (FUTA) tax 940 January 313.

April 30, July 31, October 31, and January 31,

but only if the liability for unpaid tax is more

than $500.

Filing information returns for payments tononemployees and transactions with other

persons

See Information Returns Forms 1099 to the recipient by January 31and to the IRS by February 28 (March 31 if

filing electronically).Other forms see the General Instructions for

Certain Information Returns.

Excise tax See Excise Taxes See the instructions to the forms.

1 If a due date falls on a Saturday, Sunday, or legal holiday, file by the next day that is not a Saturday, Sunday, or legal holiday. For more information, see Publication

509, Tax Calendars.2 File a separate schedule for each business.3 See the form instructions if you go out of business, change the form of your business, or stop paying wages.



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If you incorrectly classify an employee as an in-dependent contractor, you may be held liable foremployment taxes for that worker plus a penalty.

An independent contractor is someone who is self-em-ployed. You do not generally have to withhold or pay anytaxes on payments made to an independent contractor.

Excise Taxes

This section identifies some of the excise taxes you mayhave to pay and the forms you have to file if you do any ofthe following.

Manufacture or sell certain products.

Operate certain kinds of businesses.

Use various kinds of equipment, facilities, or products.

Receive payment for certain services.

For more information on excise taxes, see Publication510, Excise Taxes.

Form 720. The federal excise taxes reported on Form720, Quarterly Federal Excise Tax Return, consist of sev-eral broad categories of taxes, including the following.

Environmental taxes on the sale or use of ozone-de-pleting chemicals and imported products containing ormanufactured with these chemicals.

Communications and air transportation taxes.

Fuel taxes.

Tax on the first retail sale of heavy trucks, trailers, andtractors.

Manufacturers taxes on the sale or use of a variety of

different articles.

Tax on indoor tanning services.

Form 2290. There is a federal excise tax on the use ofcertain trucks, truck tractors, and buses on public high-ways. The tax applies to vehicles having a taxable grossweight of 55,000 pounds or more. Report the tax on Form2290, Heavy Highway Vehicle Use Tax Return. For moreinformation, see the Instructions for Form 2290.

Depositing excise taxes. If you have to file a quarterlyexcise tax return on Form 720, you may have to deposityour excise taxes before the return is due. For details on

depositing excise taxes, see the Instructions for Form720.

Information ReturnsIf you make or receive payments in your business, youmay have to report them to the IRS on information returns.The IRS compares the payments shown on the informa-tion returns with each person's income tax return to see ifthe payments were included in income. You must give acopy of each information return you are required to file to

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!the recipient or payer. In addition to the forms describedbelow, you may have to use other returns to report certainkinds of payments or transactions. For more details on in-formation returns and when you have to file them, see theGeneral Instructions for Certain Information Returns.

Form 1099-MISC. Use Form 1099-MISC, MiscellaneousIncome, to report certain payments you make in your busi-ness. These payments include the following items.

Payments of $600 or more for services performed for

your business by people not treated as your employ-ees, such as fees to subcontractors, attorneys, ac-countants, or directors.

Rent payments of $600 or more, other than rents paidto real estate agents.

Prizes and awards of $600 or more that are not forservices, such as winnings on TV or radio shows.

Royalty payments of $10 or more.

Payments to certain crew members by operators offishing boats.

You also use Form 1099-MISC to report your sales of$5,000 or more of consumer goods to a person for resaleanywhere other than in a permanent retail establishment.

Form W-2. You must file Form W-2, Wage and TaxStatement, to report payments to your employees, suchas wages, tips, and other compensation, withheld income,social security, and Medicare taxes. You can file FormW-2 online. For more information about Form W-2, seethe Instructions for Forms W-2 and W-3.

Penalties. The law provides for the following penalties ifyou do not file Form 1099-MISC or Form W-2 or do notcorrectly report the information. For more information, see

the General Instructions for Certain Information Returns.Failure to file information returns. This penalty appliesif you do not file information returns by the due date,do not include all required information, or report incor-rect information.

Failure to furnish correct payee statements. This pen-alty applies if you do not furnish a required statementto a payee by the required date, do not include all re-quired information, or report incorrect information.

Waiver of penalties. These penalties will not apply ifyou can show that the failure was due to reasonablecause and not willful neglect.

In addition, there is no penalty for failure to include allrequired information, or for including incorrect information,on a de minimis (small) number of information returns ifyou correct the errors by August 1 of the year the returnsare due. (A de minimis number of returns is the greater of10 or 1 2 of 1% of the total number of returns you are re-quired to file for the year.)

Form 8300. You must file Form 8300, Report of CashPayments Over $10,000 Received in a Trade or Business,if you receive more than $10,000 in cash in one transac-tion, or two or more related business transactions. Cash



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includes U.S. and foreign coin and currency. It also in-cludes certain monetary instruments such as cashier'sand traveler's checks and money orders. Cash does notinclude a check drawn on an individual's personal account(personal check). For more information, see Publication1544, Reporting Cash Payments of Over $10,000 (Re-ceived in a Trade or Business).

Penalties. There are civil and criminal penalties, in-cluding up to 5 years in prison, for not filing Form 8300, fil-ing (or causing the filing of) a false or fraudulent Form

8300, or structuring a transaction to evade reporting re-quirements.

2.

Accounting Periods and

Methods

IntroductionYou must figure your taxable income and file an incometax return for an annual accounting period called a taxyear. Also, you must consistently use an accountingmethod that clearly shows your income and expenses forthe tax year.


Publication

Accounting Periods and Methods


Accounting PeriodsWhen preparing a statement of income and expenses(generally your income tax return), you must use yourbooks and records for a specific interval of time called anaccounting period. The annual accounting period for yourincome tax return is called atax year. You can use one ofthe following tax years.

A calendar tax year.

A fiscal tax year.

Unless you have a required tax year, you adopt a tax yearby filing your first income tax return using that tax year. Arequired tax year is a tax year required under the InternalRevenue Code or the Income Tax Regulations.

Calendar tax year. A calendar tax year is 12 consecu-tive months beginning January 1 and ending December31.

You must adopt the calendar tax year if any of the fol-lowing apply.

You do not keep books.

You have no annual accounting period.

538

Going Out of Business Checklists

(Note.The following checklists highlight the typical final forms and schedules you may need to file if you ever go out ofbusiness. For more information, see the instructions for the listed forms.)

IF you are liable for: THEN you may need to:

Income tax File Schedule C or C-EZ with your Form 1040 for the year in which you go out of business.

File Form 4797 with your Form 1040 for each year in which you sell or exchange property used

in your business or in which the business use of certain section 179 or listed property drops to

50% or less.

File Form 8594 with your Form 1040 if you sold your business.

Self-employment tax File Schedule SE with your Form 1040 for the year in which you go out of business.

Employment taxes File Form 941 (or Form 944) for the calendar quarter in which you make final wage payments.

Note. Do not forget to check the box and enter the date final wages were paid on line 17 ofForm 941 or line 15 of Form 944.

File Form 940 for the calendar year in which final wages were paid. Note. Do not forget to checkbox d, Final: Business closed or stopped paying wages, under Type of Return.

Information returns Provide Forms W-2 to your employees for the calendar year in which you make final wage

payments. Note. These forms are generally due by the due date of your final Form 941 or Form

944.

File Form W-3 to file Forms W-2. Note. These forms are generally due within 1 month after the

due date of your final Form 941 or Form 944.

Provide Forms 1099-MISC to each person to whom you have paid at least $600 for services

(including parts and materials) during the calendar year in which you go out of business.File Form 1096 to file Forms 1099-MISC.

Table 1-3.

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Your present tax year does not qualify as a fiscal year.

Your use of the calendar tax year is required under theInternal Revenue Code or the Income Tax Regula-tions.

If you filed your first income tax return using the calen-dar tax year and you later begin business as a sole pro-prietor, you must continue to use the calendar tax year un-less you get IRS approval to change it or are otherwiseallowed to change it without IRS approval. For more infor-

mation, see Change in tax year, later.If you adopt the calendar tax year, you must maintain

your books and records and report your income and ex-penses for the period from January 1 through December31 of each year.

Fiscal tax year. A fiscal tax year is 12 consecutivemonths ending on the last day of any month except De-cember. A 52-53-week tax year is a fiscal tax year thatvaries from 52 to 53 weeks but does not have to end onthe last day of a month.

If you adopt a fiscal tax year, you must maintain yourbooks and records and report your income and expenses

using the same tax year.For more information on a fiscal tax year, including a52-53-week tax year, see Publication 538.

Change in tax year. Generally, you must file Form1128, Application To Adopt, Change, or Retain a TaxYear, to request IRS approval to change your tax year.See the Instructions for Form 1128 for exceptions. If youqualify for an automatic approval request, a user fee is notrequired. If you do not qualify for automatic approval, a rul-ing must be requested. See the instructions for Form 1128for information about user fees if you are requesting a rul-ing.

Accounting MethodsAn accounting method is a set of rules used to determinewhen and how income and expenses are reported. Youraccounting method includes not only the overall methodof accounting you use, but also the accounting treatmentyou use for any material item.

You choose an accounting method for your businesswhen you file your first income tax return that includes aSchedule C for the business. After that, if you want tochange your accounting method, you must generally getIRS approval. See Change in Accounting Method, later.

Kinds of methods. Generally, you can use any of the fol-lowing accounting methods.

Cash method.

An accrual method.

Special methods of accounting for certain items of in-come and expenses.

Combination method using elements of two or more ofthe above.

You must use the same accounting method to figureyour taxable income and to keep your books. Also, youmust use an accounting method that clearly shows yourincome.

Business and personal items. You can account forbusiness and personal items under different accountingmethods. For example, you can figure your business in-come under an accrual method, even if you use the cashmethod to figure personal items.

Two or more businesses. If you have two or more sep-arate and distinct businesses, you can use a different ac-counting method for each if the method clearly reflects theincome of each business. They are separate and distinctonly if you maintain complete and separate books and re-cords for each business.

Cash Method

Most individuals and many sole proprietors with no inven-tory use the cash method because they find it easier tokeep cash method records. However, if an inventory is

necessary to account for your income, you must generallyuse an accrual method of accounting for sales and pur-chases. For more information, see Inventories, later.

Income

Under the cash method, include in your gross income allitems of income you actually or constructively receive dur-ing your tax year. If you receive property or services, youmust include their fair market value in income.

Example. On December 30, 2011, Mrs. Sycamoresent you a check for interior decorating services you pro-vided to her. You received the check on January 2, 2012.You must include the amount of the check in income for2012.

Constructive receipt. You have constructive receipt ofincome when an amount is credited to your account ormade available to you without restriction. You do not needto have possession of it. If you authorize someone to beyour agent and receive income for you, you are treated ashaving received it when your agent received it.

Example. Interest is credited to your bank account inDecember 2012. You do not withdraw it or enter it intoyour passbook until 2013. You must include it in your

gross income for 2012.Delaying receipt of income. You cannot hold checks

or postpone taking possession of similar property fromone tax year to another to avoid paying tax on the income.You must report the income in the year the property is re-ceived or made available to you without restriction.

Example. Frances Jones, a service contractor, wasentitled to receive a $10,000 payment on a contract in De-cember 2012. She was told in December that her pay-ment was available. At her request, she was not paid until

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January 2013. She must include this payment in her 2012income because it was constructively received in 2012.

Checks. Receipt of a valid check by the end of the taxyear is constructive receipt of income in that year, even ifyou cannot cash or deposit the check until the followingyear.

Example. Dr. Redd received a check for $500 on De-cember 31, 2012, from a patient. She could not depositthe check in her business account until January 2, 2013.She must include this fee in her income for 2012.

Debts paid by another person or canceled. If yourdebts are paid by another person or are canceled by yourcreditors, you may have to report part or all of this debt re-lief as income. If you receive income in this way, you con-structively receive the income when the debt is canceledor paid. For more information, seeCanceled Debt underKinds of Income in chapter 5.

Repayment of income. If you include an amount in in-come and in a later year you have to repay all or part of it,you can usually deduct the repayment in the year in whichyou make it. If the amount you repay is over $3,000, aspecial rule applies. For details about the special rule, seeRepayments in chapter 11 of Publication 535, BusinessExpenses.

Expenses

Under the cash method, you generally deduct expensesin the tax year in which you actually pay them. This in-cludes business expenses for which you contest liability.However, you may not be able to deduct an expense paidin advance or you may be required to capitalize certaincosts, as explained later under Uniform CapitalizationRules.

Expenses paid in advance. You can deduct an ex-pense you pay in advance only in the year to which it ap-plies.

Example. You are a calendar year taxpayer and youpay $1,000 in 2012 for a business insurance policy effec-tive for one year, beginning July 1. You can deduct $500in 2012 and $500 in 2013.

Accrual Method

Under an accrual method of accounting, you generally re-

port income in the year earned and deduct or capitalizeexpenses in the year incurred. The purpose of an accrualmethod of accounting is to match income and expenses inthe correct year.

IncomeGeneral Rule

Under an accrual method, you generally include anamount in your gross income for the tax year in which allevents that fix your right to receive the income have occur-red and you can determine the amount with reasonableaccuracy.

Example. You are a calendar year accrual methodtaxpayer. You sold a computer on December 28, 2012.You billed the customer in the first week of January 2013,but you did not receive payment until February 2013. Youmust include the amount received for the computer in your2012 income.

IncomeSpecial Rules

The following are special rules that apply to advance pay-

ments, estimating income, and changing a paymentschedule for services.

Estimated income. If you include a reasonably estima-ted amount in gross income, and later determine the exactamount is different, take the difference into account in thetax year in which you make the determination.

Change in payment schedule for services. If you per-form services for a basic rate specified in a contract, youmust accrue the income at the basic rate, even if youagree to receive payments at a lower rate until you com-plete the services and then receive the difference.

Advance payments for services. Generally, you reportan advance payment for services to be performed in alater tax year as income in the year you receive the pay-ment. However, if you receive an advance payment forservices you agree to perform by the end of the next taxyear, you can elect to postpone including the advancepayment in income until the next tax year. However, youcannot postpone including any payment beyond that taxyear.

For more information, see Advance Payment for Serv-ices underAccrual Methodin Publication 538. That publi-cation also explains special rules for reporting the follow-ing types of income.

Advance payments for service agreements.

Prepaid rent.

Advance payments for sales. Special rules apply to in-cluding income from advance payments on agreementsfor future sales or other dispositions of goods you hold pri-marily for sale to your customers in the ordinary course ofyour business. If the advance payments are for contractsinvolving both the sale and service of goods, it may benecessary to treat them as two agreements. An agree-ment includes a gift certificate that can be redeemed forgoods. Treat amounts that are due and payable as

amounts you received.You generally include an advance payment in incomefor the tax year in which you receive it. However, you canuse an alternative method. For information about the alter-native method, see Publication 538.

Expenses

Under an accrual method of accounting, you generally de-duct or capitalize a business expense when both the fol-lowing apply.



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1. The all-events test has been met. The test has beenmet when:

a. All events have occurred that fix the fact of liability,and

b. The liability can be determined with reasonableaccuracy.

2. Economic performance has occurred.

Economic performance. You generally cannot deductor capitalize a business expense until economic perform-ance occurs. If your expense is for property or servicesprovided to you, or for your use of property, economic per-formance occurs as the property or services are providedor as the property is used. If your expense is for propertyor services you provide to others, economic performanceoccurs as you provide the property or services. An excep-tion allows certain recurring items to be treated as incur-red during a tax year even though economic performancehas not occurred. For more information on economic per-formance, see Economic Performance under AccrualMethodin Publication 538.

Example. You are a calendar year taxpayer and usean accrual method of accounting. You buy office suppliesin December 2012. You receive the supplies and the bill inDecember, but you pay the bill in January 2013. You candeduct the expense in 2012 because all events that fix thefact of liability have occurred, the amount of the liabilitycould be reasonably determined, and economic perform-ance occurred in that year.

Your office supplies may qualify as a recurring ex-pense. In that case, you can deduct them in 2012 even ifthe supplies are not delivered until 2013 (when economicperformance occurs).

Keeping inventories. When the production, purchase,or sale of merchandise is an income-producing factor inyour business, you must generally take inventories intoaccount at the beginning and the end of your tax year. Ifyou must account for an inventory, you must generally usean accrual method of accounting for your purchases andsales. For more information, see Inventories, later.

Special rule for related persons. You cannot deductbusiness expenses and interest owed to a related personwho uses the cash method of accounting until you makethe payment and the corresponding amount is includiblein the related person's gross income. Determine the rela-tionship, for this rule, as of the end of the tax year for

which the expense or interest would otherwise be deducti-ble. If a deduction is not allowed under this rule, the rulewill continue to apply even if your relationship with the per-son ends before the expense or interest is includible in thegross income of that person.

Related persons include members of your immediatefamily, including only brothers and sisters (either whole orhalf), your spouse, ancestors, and lineal descendants. Fora list of other related persons, see section 267 of the Inter-nal Revenue Code.

Combination Method

You can generally use any combination of cash, accrual,and special methods of accounting if the combinationclearly shows your income and expenses and you use itconsistently. However, the following restrictions apply.

If an inventory is necessary to account for your in-come, you must generally use an accrual method forpurchases and sales. (See, however, Inventories,

later.) You can use the cash method for all other itemsof income and expenses.

If you use the cash method for figuring your income,you must use the cash method for reporting your ex-penses.

If you use an accrual method for reporting your expen-ses, you must use an accrual method for figuring yourincome.

If you use a combination method that includes thecash method, treat that combination method as thecash method.

InventoriesGenerally, if you produce, purchase, or sell merchandisein your business, you must keep an inventory and use theaccrual method for purchases and sales of merchandise.However, the following taxpayers can use the cashmethod of accounting even if they produce, purchase, orsell merchandise. These taxpayers can also account forinventoriable items as materials and supplies that are notincidental (discussed later).

1. A qualifying taxpayer under Revenue Procedure2001-10 in Internal Revenue Bulletin 2001-2.

2. A qualifying small business taxpayer under RevenueProcedure 2002-28 in Internal Revenue Bulletin2002-18.

Qualifying taxpayer. You are a qualifying taxpayer if:

Your average annual gross receipts for each prior taxyear ending on or after December 17, 1998, is $1 mil-lion or less. (Your average annual gross receipts for atax year is figured by adding the gross receipts for thattax year and the 2 preceding tax years and dividing by3.)

Your business is not a tax shelter, as defined undersection 448(d)(3) of the Internal Revenue Code.

Qualifying small business taxpayer. You are a qualify-ing small business taxpayer if:

Your average annual gross receipts for each prior taxyear ending on or after December 31, 2000, is morethan $1 million but not more than $10 million. (Youraverage annual gross receipts for a tax year is figuredby adding the gross receipts for that tax year and the 2preceding tax years and dividing the total by 3.)

You are not prohibited from using the cash methodunder section 448 of the Internal Revenue Code.

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Your principal business activity is an eligible business(described in Publication 538 and Revenue Procedure2002-28).

Business not owned or not in existence for 3 years.If you did not own your business for all of the 3-tax-yearperiod used in figuring your average annual gross re-ceipts, include the period of any predecessor. If your busi-ness has not been in existence for the 3-tax-year period,base your average on the period it has existed including

any short tax years, annualizing the short tax year's grossreceipts.

Materials and supplies that are not incidental. If youaccount for inventoriable items as materials and suppliesthat are not incidental, you will deduct the cost of theitems you would otherwise include in inventory in the yearyou sell the items, or the year you pay for them, whicheveris later. If you are a producer, you can use any reasonablemethod to estimate the raw material in your work in proc-ess and finished goods on hand at the end of the year todetermine the raw material used to produce finishedgoods that were sold during the year.

Changing accounting method. If you are a qualifyingtaxpayer or qualifying small business taxpayer and wantto change to the cash method or to account for inventoria-ble items as non-incidental materials and supplies, youmust fileForm 3115, Application for Change in Account-ing Method. See Change in Accounting Method, later.

More information. For more information about the quali-fying taxpayer exception, see Revenue Procedure2001-10 in Internal Revenue Bulletin 2001-2. For more in-formation about the qualifying small business taxpayer ex-ception, see Revenue Procedure 2002-28 in Internal Rev-enue Bulletin 2002-18.

Items included in inventory. If you are required to ac-count for inventories, include the following items when ac-counting for your inventory.

Merchandise or stock in trade.

Raw materials.

Work in process.

Finished products.

Supplies that physically become a part of the item in-tended for sale.

Valuing inventory. You must value your inventory at thebeginning and end of each tax year to determine your costof goods sold (Schedule C, line 42). To determine thevalue of your inventory, you need a method for identifyingthe items in your inventory and a method for valuing theseitems.

Inventory valuation rules cannot be the same for allkinds of businesses. The method you use to value your in-ventory must conform to generally accepted accountingprinciples for similar businesses and must clearly reflect

income. Your inventory practices must be consistent fromyear to year.

More information. For more information about invento-ries, see Publication 538.

Uniform Capitalization Rules

Under the uniform capitalization rules, you must capitalizethe direct costs and part of the indirect costs for produc-

tion or resale activities. Include these costs in the basis ofproperty you produce or acquire for resale, rather thanclaiming them as a current deduction. You recover thecosts through depreciation, amortization, or cost of goodssold when you use, sell, or otherwise dispose of the prop-erty.

Activities subject to the uniform capitalization rules.You may be subject to the uniform capitalization rules ifyou do any of the following, unless the property is pro-duced for your use other than in a business or an activitycarried on for profit.

Produce real or tangible personal property. For this

purpose, tangible personal property includes a film,sound recording, video tape, book, or similar property.

Acquire property for resale.

Exceptions. These rules do not apply to the followingproperty.

1. Personal property you acquire for resale if your aver-age annual gross receipts are $10 million or less.

2. Property you produce if you meet either of the follow-ing conditions.

a. Your indirect costs of producing the property are$200,000 or less.

b. You use the cash method of accounting and donot account for inventories. For more information,see Inventories, earlier.

Special Methods

There are special methods of accounting for certain itemsof income or expense. These include the following.

Amortization, discussed in chapter 8 of Publication535, Business Expenses.

Bad debts, discussed in chapter 10 of Publication

535.Depletion, discussed in chapter 9 of Publication 535.

Depreciation, discussed in Publication 946, How ToDepreciate Property.

Installment sales, discussed in Publication 537, In-stallment Sales.



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Change inAccounting Method

Once you have set up your accounting method, you mustgenerally get IRS approval before you can change to an-other method. A change in your accounting method in-cludes a change in:

1. Your overall method, such as from cash to an accrualmethod, and

2. Your treatment of any material item.

To get approval, you must file Form 3115, Application forChange in Accounting Method. You can get IRS approvalto change an accounting method under either the auto-matic change procedures or the advance consent requestprocedures. You may have to pay a user fee. For more in-formation, see the form instructions.

Automatic change procedures. Certain taxpayers canpresume to have IRS approval to change their method ofaccounting. The approval is granted for the tax year forwhich the taxpayer requests a change (year of change), if

the taxpayer complies with the provisions of the automaticchange procedures. No user fee is required for an appli-cation filed under an automatic change procedure gener-ally covered in Revenue Procedure 2002-9.

Generally, you must use Form 3115 to request an auto-matic change. For more information, see the Instructionsfor Form 3115.

3.

Dispositions of

Business Property

IntroductionIf you dispose of business property, you may have a gainor loss that you report on Form 1040. However, in somecases you may have a gain that is not taxable or a lossthat is not deductible. This chapter discusses whether youhave a disposition, how to figure the gain or loss, and

where to report the gain or loss.


Publication

Sales and Other Dispositions of Assets


Sales of Business Property

544

4797

Capital Gains and Losses


What Is a Dispositionof Property?A disposition of property includes the following transac-tions.

You sell property for cash or other property.

You exchange property for other property.

You receive money as a tenant for the cancellation ofa lease.

You receive money for granting the exclusive use of acopyright throughout its life in a particular medium.

You transfer property to satisfy a debt.

You abandon property.

Your bank or other financial institution forecloses on

your mortgage or repossesses your property.

Your property is damaged, destroyed, or stolen, andyou receive property or money in payment.

Your property is condemned, or disposed of under thethreat of condemnation, and you receive property ormoney in payment.

For details about damaged, destroyed, or stolen property,see Publication 547, Casualties, Disasters, and Thefts.For details about other dispositions, see chapter 1 in Pub-lication 544.

Nontaxable exchanges. Certain exchanges of property

are not taxable. This means any gain from the exchangeis not recognized and you cannot deduct any loss. Yourgain or loss will not be recognized until you sell or other-wise dispose of the property you receive.

Like-kind exchanges. A like-kind exchange is the ex-change of property for the same kind of property. It is themost common type of nontaxable exchange. To be alike-kind exchange, the property traded and the propertyreceived must be both of the following.

Business or investment property.

Like property.

Report the exchange of like-kind property on Form8824, Like-Kind Exchanges. For more information aboutlike-kind exchanges, see chapter 1 in Publication 544.

Installment sales. An installment sale is a sale of prop-erty where you receive at least one payment after the taxyear of the sale. If you finance the buyer's purchase ofyour property, instead of having the buyer get a loan ormortgage from a third party, you probably have an install-ment sale.

For more information about installment sales, see Pub-lication 537, Installment Sales.

Sch D (Form 1040)

Page 16 Chapter 3 Dispositions of Business Property


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Sale of a business. The sale of a business usually is nota sale of one asset. Instead, all the assets of the businessare sold. Generally, when this occurs, each asset is trea-ted as being sold separately for determining the treatmentof gain or loss.

Both the buyer and seller involved in the sale of a busi-ness must report to the IRS the allocation of the salesprice among the business assets. Use Form 8594, AssetAcquisition Statement Under Section 1060, to provide thisinformation. The buyer and seller should each attach

Form 8594 to their federal income tax return for the year inwhich the sale occurred.

For more information about the sale of a business, seechapter 2 of Publication 544.

How Do I Figurea Gain or Loss?

Table 3-1. How To Figure a Gain or Loss

IF your... THEN you have a...

Adjusted basis is more than the amount

realized Loss.

Amount realized is more than theadjusted basis Gain.

Basis, adjusted basis, amount realized, fair marketvalue, and amount recognized are defined next. You needto know these definitions to figure your gain or loss.

Basis. The cost or purchase price of property is usuallyits basis for figuring the gain or loss from its sale or otherdisposition. However, if you acquired the property by gift,inheritance, or in some way other than buying it, you mustuse a basis other than its cost. For more information about

basis, see Publication 551, Basis of Assets.

Adjusted basis. The adjusted basis of property is youroriginal cost or other basis plus certain additions, and mi-nus certain deductions such as depreciation and casualtylosses. In determining gain or loss, the costs of transfer-ring property to a new owner, such as selling expenses,are added to the adjusted basis of the property.

Amount realized. The amount you realize from a dispo-sition is the total of all money you receive plus the fairmarket value of all property or services you receive. Theamount you realize also includes any of your liabilities thatwere assumed by the buyer and any liabilities to which the

property you transferred is subject, such as real estatetaxes or a mortgage.

Fair market value. Fair market value is the price atwhich the property would change hands between a buyerand a seller, neither having to buy or sell, and both havingreasonable knowledge of all necessary facts.

Amount recognized. Your gain or loss realized from adisposition of property is usually a recognized gain or lossfor tax purposes. Recognized gains must be included ingross income. Recognized losses are deductible from

gross income. However, a gain or loss realized from cer-tain exchanges of property is not recognized. SeeNontaxable exchanges, earlier. Also, you cannot deduct aloss from the disposition of property held for personal use.

Is My Gain or LossOrdinary or Capital?

You must classify your gains and losses as either ordinary

or capital gains or losses. You must do this to figure yournet capital gain or loss. Generally, you will have a capitalgain or loss if you dispose of a capital asset. For the mostpart, everything you own and use for personal purposes orinvestment is a capital asset.

Certain property you use in your business is not a capi-tal asset. A gain or loss from a disposition of this propertyis an ordinary gain or loss. However, if you held the prop-erty longer than 1 year, you may be able to treat the gainor loss as a capital gain or loss. These gains and lossesare called section 1231 gains and losses.

For more information about ordinary and capital gains

and losses, see chapters 2 and 3 in Publication 544.

Is My Capital Gain or LossShort Term or Long Term?

If you have a capital gain or loss, you must determinewhether it is long term or short term. Whether a gain orloss is long or short term depends on how long you ownthe property before you dispose of it. The time you ownproperty before disposing of it is called the holding period.

Do I Have a Short-Term or

Long-Term Gain or Loss?

Table 3-2.

IF you hold the property... THEN you have a...

1 year or less Short-term capital gain or loss.

More than 1 year Long-term capital gain or loss.

For more information about short-term and long-termcapital gains and losses, see chapter 4 of Publication 544.

Where Do I ReportGains and Losses?

Report gains and losses from the following dispositions onthe forms indicated. The instructions for the forms explainhow to fill them out.

Dispositions of business property and depreciableproperty. Use Form 4797. If you have taxable gain, youmay also have to use Schedule D (Form 1040).

Like-kind exchanges. Use Form 8824, Like-Kind Ex-changes. You may also have to use Form 4797 andSchedule D (Form 1040).

Chapter 3 Dispositions of Business Property Page 17


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Installment sales. Use Form 6252, Installment Sale In-come. You may also have to use Form 4797 and Sched-ule D (Form 1040).

Casualties and thefts. Use Form 4684, Casualties andThefts. You may also have to use Form 4797.

Condemned property. Use Form 4797. You may alsohave to use Schedule D (Form 1040).

4.

General Business Credits

IntroductionYour general business credit for the year consists of yourcarryforward of business credits from prior years plus the

total of your current year business credits. In addition,your general business credit for the current year may beincreased later by the carryback of business credits fromlater years. You subtract this credit directly from your tax.



General Business Credit

Alternative Minimum TaxIndividuals

See chapter 12 for information about getting publications

and forms.

Business CreditsAll of the following credits are part of the general businesscredit. The form you use to figure each credit is shown inparentheses. You will also have to complete Form 3800.

Agricultural chemicals security credit (Form 8931).This credit applies to qualified agricultural chemical secur-ity expenses paid or incurred by eligible agricultural busi-nesses. For more information, see Form 8931.

Alcohol and cellulosic biofuel fuels credit (Form6478). For more information, see Form 6478.

Alternative fuel vehicle refueling property credit(Form 8911). This credit applies to the cost of any quali-fied fuel vehicle refueling property you placed in service.For more information, see Form 8911.

Alternative motor vehicle credit (Form 8910). Formore information, see Form 8910.

Biodiesel and renewable diesel fuels credit (Form8864). For more information, see Form 8864.

3800

6251

Carbon dioxide sequestration credit (Form 8933).This credit is for carbon dioxide which is captured at aqualified facility and disposed of in a secure geologicalstorage or used in a qualified enhanced oil or natural gasrecovery project. For more information, see Form 8933.

Credit for employer social security and Medicaretaxes paid on certain employee tips (Form 8846).This credit is generally equal to your (employer's) portionof social security and Medicare taxes paid on tips re-

ceived by employees of your food and beverage estab-lishment where tipping is customary. The credit applies re-gardless of whether the food is consumed on or off yourbusiness premises. For more information, see Form 8846.

Credit for employer differential wage payments(Form 8932). For more information, see Form 8932.

Credit for employer-provided childcare facilities andservices (Form 8882). This credit applies to the quali-fied expenses you paid for employee childcare and quali-fied expenses you paid for childcare resource and referralservices. For more information, see Form 8882.

Credit for increasing research activities (Form 6765).For more information, see Form 6765.

Credit for small employer health insurance premi-ums (Form 8941). This credit applies to the cost of cer-tain health insurance coverage you provide to certain em-ployees. For more information, see Form 8941.

Credit for small employer pension plan startup costs(Form 8881). This credit applies to pension plan startupcosts of a new qualified defined benefit or defined contri-bution plan (including a 401(k) plan), SIMPLE plan, orsimplified employee pension. For more information, seePublication 560, Retirement Plans for Small Business

(SEP, SIMPLE, and Qualified Plans).

Disabled access credit (Form 8826). This credit is anonrefundable tax credit for an eligible small business thatpays or incurs expenses to provide access to personswho have disabilities. You must pay or incur the expensesto enable your business to comply with the Americanswith Disabilities Act of 1990. For more information, seeForm 8826.

Distilled spirits credit (Form 8906). This credit is avail-able to distillers and importers of distilled spirits and eligi-ble wholesalers of distilled spirits. For more information,see Form 8906.

Empowerment zone and renewal community employ-ment credit (Form 8844). For more information, seeForm 8844.

Energy efficient appliance credit (Form 8909). Formore information, see Form 8909.

Energy efficient home credit (Form 8908). For moreinformation, see Form 8908.

Page 18 Chapter 4 General Business Credits


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Indian employment credit (Form 8845). For more in-formation, see Form 8845.

Investment credit (Form 3468). For more information,see Form 3468.

Low sulfur diesel fuel production credit (Form 8896).This credit is for the production of low sulfur diesel fuel bya qualified small business. For more information, seeForm 8896.

Low-income housing credit (Form 8586). This creditgenerally applies to each new qualified low-income build-ing placed in service after 1986. For more information, seeForm 8586.

Mine rescue team training credit (Form 8923). Formore information, see Form 8923.

New markets credit (Form 8874). This credit is forqualified equity investments made in qualified communitydevelopment entities. For more information, see Form8874.

Nonconventional source fuel credit (Form 8907).This credit is for qualified coke and coke gas you pro-duced and sold to an unrelated person during the taxyear. For more information, see Form 8907.

Orphan drug credit (Form 8820). This credit applies toqualified expenses incurred in testing certain drugs forrare diseases and conditions. For more information, seeForm 8820.

Qualified plug-in electric drive motor vehicle credit(Form 8936). This credit is for new qualified plug-in elec-tric drive motor vehicles placed in service during the taxyear. For more information, including information on what

is considered as a qualified plug-in electric drive motor ve-hicle, see Form 8936.

Qualified plug-in electric vehicle credit (Form 8834,Part I only). This portion of the credit is for certain quali-fied plug-in electric vehicles. See Form 8834 for more in-formation, including information on what is considered asa qualified plug-in electric vehicle.

Qualified railroad track maintenance credit (Form8900). For more information, see Form 8900.

Renewable electricity, refined coal, and Indian coalproduction credit (Form 8835). This credit is for the

sale of electricity, refined coal, or Indian coal produced inthe United States or U.S. possessions from qualified en-ergy resources at a qualified facility. For more information,see Form 8835.

Work opportunity credit (Form 5884). This credit pro-vides businesses with an incentive to hire individuals fromtargeted groups that have a particularly high unemploy-ment rate or other special employment needs. For moreinformation, see Form 5884.

How To Claim the CreditTo claim a general business credit, you will first have toget the forms you need to claim your current year busi-ness credits.

In addition to the credit form, you also need to file Form3800.

5.

Business Income

IntroductionThis chapter primarily explains business income and howto account for it on your tax return, what items are not con-sidered income, and gives guidelines for selected occupa-tions.

If there is a connection between any income you re-ceive and your business, the income is business income.A connection exists if it is clear that the payment of in-come would not have been made if you did not have thebusiness.

You can have business income even if you are not in-volved in the activity on a regular full-time basis. Incomefrom work you do on the side in addition to your regularjob can be business income.

You report most business income, such as incomefrom selling your products or services, on Schedule C orC-EZ. But you report the income from the sale of business

assets, such as land and office buildings, on other formsinstead of Schedule C or C-EZ. For information on sellingbusiness assets, see chapter 3.

Nonemployee compensation. Business in-come includes amounts you received in yourbusiness that were properly shown on Forms

1099-MISC. This includes amounts reported as nonem-ployee compensation in box 7 of the form. You can findmore information in the instructions on the back of theForm 1099-MISC you received.

Kinds of IncomeYou must report on your tax return all income you receivefrom your business unless it is excluded by law. In mostcases, your business income will be in the form of cash,checks, and credit card charges. But business incomecan be in other forms, such as property or services. Theseand other types of income are explained next.

If you are a U.S. citizen who has business incomefrom sources outside the United States (foreignincome), you must report that income on your tax

return unless it is exempt from tax under U.S. law. If you

TIP

CAUTION

!

Chapter 5 Business Income Page 19


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live outside the United States, you may be able to excludepart or all of your foreign-source business income. For de-tails, see Publication 54, Tax Guide for U.S. Citizens andResident Aliens Abroad.

Bartering for Property or Services

Bartering is an exchange of property or services. Youmust include in your gross recei

p334 tax guide for small business

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