Schedule C Explained: Sole Proprietorship Taxation for EA Candidates

2026-07-10

Last reviewed: July 9, 2026. This article reflects current IRS rules and EA exam requirements as of this date.

Schedule C is where sole proprietors report business profit and loss. It's one of the most heavily tested topics on Part 1 and Part 2 of the EA exam. Every line has exam significance.

The Five Parts of Schedule C

Part I. Income: Gross receipts, returns and allowances, cost of goods sold. Net receipts flow to gross profit. Other income (federal fuel credits, recaptured depreciation) is added.

Part II. Expenses: The full list: advertising, vehicle expenses, commissions, contract labor, depletion, depreciation, employee benefits, insurance, mortgage interest, other interest, legal/professional, office, pension/profit-sharing, rent, repairs, supplies, taxes, travel, meals (50%), utilities, wages, home office, and other.

Part III. Cost of Goods Sold: For businesses that sell products. Beginning inventory + purchases + labor + materials + other costs - ending inventory = COGS. This matters because COGS reduces gross income differently than expenses.

Part IV. Vehicle Information: Mileage, date placed in service, business use percentage, commuting miles. Required when claiming vehicle expenses.

Part V. Other Expenses: Anything not listed in Part II. Each expense must be listed separately with a description and amount.

What's Deductible

The standard: ordinary and necessary business expenses. "Ordinary" means common in your industry. "Necessary" means helpful and appropriate. Not absolutely essential.

Home office deduction: Exclusive and regular use of a specific area for business. Two methods: simplified ($5 per sq ft, max 300 sq ft = $1,500) or regular (actual expenses prorated by square footage percentage).

Vehicle expenses: Standard mileage rate (check current year) × business miles, or actual expenses × business use percentage. If you use standard mileage the first year, you can switch later. If you use actual the first year, you're locked into actual for that vehicle.

Meals: 50% deductible. Must be directly related to or associated with business. Entertainment is no longer deductible (TCJA change).

Travel: Transportation (airfare, taxi, rental car), lodging, 50% of meals, laundry, tips. Must be away from your tax home overnight. The trip must be primarily for business.

What's NOT Deductible

Commuting between home and regular workplace
Personal expenses disguised as business
Entertainment (even if business-related)
Political contributions
Fines and penalties
Clothing that can be worn outside work (unless it's a uniform required by employer and not suitable for everyday wear)

Common EA Exam Traps

Trap 1: The hobby loss rule. If an activity doesn't make a profit in 3 of 5 consecutive years (2 of 7 for horse breeding), the IRS presumes it's a hobby. Hobby expenses are deductible only up to hobby income (miscellaneous, pre-2018 rules apply). The distinction between business and hobby is heavily tested.

Trap 2: Self-employment tax. Schedule C net profit flows to Schedule SE. You pay both employer and employee portions of FICA (15.3% total). But you get a deduction for half of SE tax on Schedule 1. An above-the-line adjustment. Students forget this deduction constantly.

Trap 3: Home office exclusivity. If the room is also a guest bedroom or the kids do homework there, it doesn't qualify. Period. The EA exam will describe a room with dual use and expect you to flag it as non-deductible.

Need to reference Schedule C or other forms? The IRS Form Lookup has 19 forms with purpose, key sections, and EA exam relevance.

Practice Schedule C questions →