What Is an IRS Profit and Loss Statement?

A profit and loss (P&L) statement is a financial report for any business, offering a snapshot of financial performance over a specific period, such as a month, quarter, or year. It systematically lists all revenue generated and all expenses incurred. The calculation is total revenues minus total expenses, which equals net income or net loss.

This financial summary is the foundation for calculating a business’s tax obligations. The net income figure derived from the P&L statement is what the Internal Revenue Service (IRS) considers when determining how much tax a business owes. For this reason, understanding how to properly structure and report this information is a primary responsibility for any business owner.

The IRS’s Version of a Profit and Loss Statement

The IRS does not have a specific, standalone document titled “IRS Profit and Loss Statement.” Instead, the agency requires businesses to report their financial results on specific tax forms that function as the official P&L for tax purposes. The specific form a business uses is determined by its legal structure.

For self-employed individuals, freelancers, and independent contractors operating as sole proprietors, Schedule C (Form 1040), “Profit or Loss from Business,” is the required document. This form is filed as part of the owner’s personal tax return. Single-member Limited Liability Companies (LLCs) that have not elected to be treated as a corporation also use Schedule C.

Other business structures use different forms to report their profit and loss. Partnerships and multi-member LLCs file Form 1065, “U.S. Return of Partnership Income.” C corporations report on Form 1120, “U.S. Corporation Income Tax Return,” while S corporations use Form 1120-S, “U.S. Income Tax Return for an S Corporation.” Each of these forms serves as the official P&L statement for that type of entity.

Required Information for Your Tax P&L

Before you can fill out any IRS form, you must first gather and organize all the necessary financial data. This process involves compiling information related to your business’s income, the cost of goods it sold, and its various operating expenses. A thorough and accurate compilation of these figures is the most important step in preparing your business tax return.

Gross Income

The first component to assemble is your total business income. This begins with your gross receipts or sales, which is the total amount of money received from customers for goods or services before any deductions. You must account for all sources of business income, including payments received in cash, checks, and electronic transfers.

From your gross receipts, you will subtract any returns and allowances. Returns occur when a customer sends back a product, and you refund their money. Allowances are reductions in price you might give a customer for minor defects. The resulting number represents your net receipts.

Cost of Goods Sold (COGS)

If your business manufactures products or purchases goods for resale, you must calculate the Cost of Goods Sold (COGS). This figure represents the direct costs attributable to the production or acquisition of the goods you sold during the year.

The formula for calculating COGS is: start with the value of your inventory at the beginning of the year, add the cost of all purchases and materials acquired, and then subtract the value of your inventory at the end of the year. This calculation also requires you to account for the cost of labor directly involved in production.

Deductible Business Expenses

The final category is your list of deductible business expenses. The IRS defines a business expense as any cost that is both “ordinary” and “necessary” for your trade or business. An ordinary expense is one that is common and accepted in your industry, while a necessary expense is one that is helpful and appropriate for your business.

Common expense categories include:

• Advertising
• Car and truck expenses
• Insurance for business-related policies
• Interest paid on business loans
• Legal and professional fees
• Office expenses
• Rent or lease payments for vehicles and equipment
• Repairs and maintenance
• Supplies
• Taxes and licenses
• Travel expenses for business trips
• Utilities
• Wages paid to employees

Assembling Your Profit and Loss on IRS Forms

Once you have gathered your financial data, the next step is to transfer this information onto the correct IRS form. Using Schedule C (Form 1040) as the primary example, this process organizes your figures into a structured P&L statement.

The first part of Schedule C calculates your gross income. Gross receipts are entered on Line 1, returns and allowances on Line 2, and the Cost of Goods Sold (COGS) on Line 4. This information is used to calculate your gross profit on Line 5.

Part II of Schedule C is where you report your categorized business expenses. The form provides specific lines for common deductions like advertising, insurance, interest, and rent. Expenses that do not fit into the predefined categories can be detailed in Part V, “Other Expenses.”

After totaling all expenses, you calculate your net profit or loss on Line 31. This final figure is carried over to your personal Form 1040 and is used to calculate your income and self-employment taxes.

Recordkeeping for IRS Scrutiny

The IRS requires all business owners to maintain complete and accurate records to substantiate all the income, deductions, and credits reported on their tax forms. This documentation is your proof in the event of an IRS audit. Failure to provide adequate records can lead to disallowed deductions and penalties.

For income, you must keep documents such as invoices, bank deposit slips, and all Forms 1099-NEC or 1099-K that report payments made to you. For expenses, the required documentation includes receipts, canceled checks, bank and credit card statements, and invoices. For certain expenses like vehicle use, you must maintain a detailed mileage log.

The rule from the IRS is to keep records for three years from the date you filed your tax return. However, there are exceptions. If you underreport your income by more than 25%, the IRS has six years to assess additional tax. Records related to business assets should be kept until the period of limitations expires for the year in which you dispose of the asset, and employment tax records should be kept for at least four years.