Schedule C Explained: Sole Proprietorship Taxation for EA Candidates

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

Use the current IRS Schedule C guidance when checking the form-specific details in this guide.

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 →

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Related: Form 1040 Explained: Every Line EA Candidates Need to Know · Form 1065 Explained: Partnership Taxation for EA Candidates · Tax Scenarios That Trip Up Even Experienced Preparers