Schedule C Line G: What Is Material Participation?
Understand the IRS rules for material participation on Schedule C. This classification determines whether your business losses can offset other personal income.
Sole proprietors, freelancers, and independent contractors use IRS Form 1040, Schedule C, to report their annual business income and expenses. Line G on this form asks a “Yes” or “No” question that determines how your business’s financial results are treated on your personal tax return.
The Line G Question Explained
Line G of Schedule C asks: “Did you materially participate in the operation of this business during [the tax year]?” The term “material participation” is an IRS standard used to determine your level of involvement. To answer, you must assess if you participated in the business’s operations on a “regular, continuous, and substantial basis” during the year. This determination is based on the tangible work you performed, not your job title or ownership status.
The Seven Tests for Material Participation
The IRS provides seven tests to determine if you materially participated. You only need to meet one of these tests for the tax year to check “Yes” on Line G. The hours and activities of a spouse can be counted as your own participation, even if they are not a formal owner of the business and you do not file a joint return.
The 500-Hour Test
If you participated in the business activity for more than 500 hours during the tax year, you have materially participated. This equates to roughly 10 hours per week. For example, a freelance graphic designer who spends 20 hours each week on client projects and administrative tasks easily surpasses this threshold.
The Substantially All Participation Test
This test applies if your participation constituted substantially all of the participation in the activity for the tax year, including the work of all individuals, whether they are owners or not. For instance, a solo consultant who is the only person performing work for the business meets this standard, regardless of the total hours worked.
The 100-Hour and Not Less Than Anyone Else Test
You meet this test if you participated for more than 100 hours during the tax year, and your participation was not less than that of any other individual, including employees. For example, if you worked 150 hours in your retail shop and your only employee worked 120 hours, you would satisfy this requirement.
The Significant Participation Activity Test
This test applies to individuals involved in multiple business activities. An activity is a “significant participation activity” (SPA) if you participated for more than 100 hours but did not meet any of the other material participation tests. If your combined participation in all of your SPAs for the year exceeds 500 hours, you are considered to have materially participated in each of those activities.
The Prior Year Participation Test
You materially participated in the current year if you did so for any five of the preceding ten tax years. This rule prevents taxpayers from alternating between passive and active status to manipulate tax outcomes. For example, if you ran a business full-time from 2018 through 2023 and took a less active role in 2024, you would still be a material participant for 2024 based on your prior involvement.
The Personal Service Activity Test
A personal service activity involves services in fields like health, law, accounting, consulting, or performing arts. If your business is a personal service activity, you materially participated if you did so for any three prior tax years, regardless of when they occurred. This is a lifetime test.
The Facts and Circumstances Test
If you cannot meet any of the other six tests, you may qualify under this test. You must have participated in the activity for more than 100 hours on a regular and continuous basis during the year, based on all the facts and circumstances. However, your time in a management capacity does not count if a paid manager was involved or if someone else spent more hours than you managing the business.
Tax Implications of Your Answer
Your answer to the Line G question determines whether your business is a nonpassive or passive activity, which has direct consequences for how losses are treated on your tax return.
If you check “Yes,” you have materially participated, and the business is a nonpassive activity. A net loss from a nonpassive activity can generally be deducted against other nonpassive income, such as W-2 wages, interest, and dividends. This deduction can lower your overall taxable income.
If you check “No,” the business is a passive activity, and any losses are subject to the passive activity loss (PAL) rules. These rules prevent you from deducting passive losses against nonpassive income like wages. Instead, passive losses can only be used to offset income from other passive activities. You may be required to file Form 8582, “Passive Activity Loss Limitations,” to calculate any deductible loss.