Net earnings (also called net income or profit) is your gross business income minus business expenses. No matter what kind of business you have, you begin with gross income and deduct allowable expenses to get net income. Gross income is the income received directly by an individual, before any withholding, deductions, or taxes.
How you calculate net earnings for your business depends on the type of business.
Net Earnings on Schedule C
Small businesses that are formed as sole proprietors and single-member LLCs pay their
For example, a business that has an inventory of products must include a calculation for the cost of goods sold. A corporation must include compensation of corporate officers in the net earnings calculation because the IRS wants to make sure corporate officers are compensated reasonably. For a partnership tax return, guaranteed payments to partners must be included in the calculation for net earnings.
The calculation for net earnings changes based on the type of report and also for the type of business.
In Business Reports and Calculations
Net earnings are used in your business financial reports. Details of net earnings over a period of time (monthly, quarterly, yearly) are reported in your business net income (Profit and Loss) statement. The net earnings amount is also used to analyze the success of a company. The most common profitability ratio is net profit margin, which compares net income to net sales. The result is a percentage, and the higher the percentage the higher the net profit.
For Tax Reporting
The net earnings amount is the basis for calculating your business income tax. For all business legal types, the amount of tax the business pays begins with the calculation of net earnings. If you are self-employed, your net earnings from self-employment are used to calculate your Self-employment Taxes. Self-employment tax is the tax that self-employed individuals pay for Social Security and Medicare.
Calculating Net Earnings For Business Taxes
To calculate net earnings, a small business will use Schedule C (Profit or Loss from Business), which is part of the individual tax return forms. Some of these calculations are done on separate schedules, and the totals are brought into the main part of Schedule C.
- Your business income is calculated, starting with gross receipts or gross sales. Returns and allowances are deducted.
- Then, the cost of goods sold is calculated for businesses that sell products.
- The result is the gross profit (gross business income).
- Other income is also listed. For example, your business may have income from interest, tax credits, or other non-sales sources.
- Expenses are listed, in specific categories, in alphabetical order. There is a category for miscellaneous expenses too.
- If you have a home business, you can do a separate calculation for home business expenses, and add those to the tentative profit or loss.
Net Profit or Loss Calculation
- The net profit or loss calculation is Gross Income minus expenses (including home business expenses).
For Partnerships and Corporations
You will see a similar process for partnership, corporation, and S corporation income tax calculations.
Calculating Net Earnings for Self-employment Taxes
The net earnings total forms the basis for calculating self-employment taxes on Schedule SE. Some income does not count for Social Security and should not be included in figuring your net earnings:
- Dividend income: unless it is received as a dealer in stocks and securities
- Interest from loans, unless you are a real estate dealer or you regularly provide services mostly for the convenience of the occupant
- Income received from a limited partnership