What Is Business Income?
Business income is a type of earned income and is classified as ordinary income for tax purposes. It encompasses any income realized as a result of an entity’s operations. In its simplest form, it is a business entity's net profit or loss, which is calculated as its revenue from all sources minus the costs of doing business.
- Business income is earned income and encompasses any income realized from an entity’s operations.
- For tax purposes, business income is treated as ordinary income.
- Business expenses and losses often offset business income.
- How a business is taxed depends on whether it is a sole proprietorship, partnership, or corporation.
Understanding Business Income
Business income is a term commonly used in tax reporting. According to the Internal Revenue Service (IRS), “Business income may include income received from the sale of products or services. For example, fees received by a person from the regular practice of a profession are business income. Rents received by a person in the real estate business are business income. A business must include in income payments received in the form of property or services at the fair market value of the property or services.”
Business expenses and business losses can offset business income, which can be either positive or negative in any given year. The profit motive behind business income is universal to most business entities. However, the way in which business income is taxed differs for each of the most common types of businesses: sole proprietorships, partnerships, and corporations.
How business income is taxed
How a business is formed determines how it should report its income to the IRS.
- A sole proprietorship is not a legally separate entity from its owner. Therefore, business income from a sole proprietorship is reported on that individual's Form 1040 tax return using Schedule C: Profit or Loss From Business.
- A partnership is an unincorporated business that is jointly owned by two or more individuals. It reports business income on Form 1065. However, the partnership itself does not pay income tax. All partners receive a Schedule K-1 and report their share of the partnership’s income on their own individual income tax returns.
- A limited liability company (LLC) is like a hybrid between a corporation and a sole proprietorship or partnership. Single-member LLCs report business income on Form 1040, Schedule C. LLCs with more than one member use the same form used by partnerships, Form 1065. An LLC can also opt to be taxed as a C corporation or S corporation (S-corp).
- A corporation is a legally separate entity from any individual who owns it. Corporations are generally taxed as C corporations (C-corp), which means they are taxed separately from their owners. Business income from a corporation is reported on Form 1120.
- An S corporation (S-corp) is a corporation that elects to be taxed as a pass-through business. Business income for an S-corp is reported on Form 1120-S. Like a partnership, the S-corp does not pay income tax. Shareholders receive a K-1 and report their share of the company's income on their individual tax returns. Note that an S-corp is not a type of business entity, rather a tax filing election that an LLC or C-corp can elect after forming.
Business income coverage is a type of insurance that covers company losses due to a slowdown or temporary suspension of normal operations resulting from damage to a business’s physical property.
Insurance Coverage for Business Income
A business income coverage form is a type of property insurance policy that covers a company’s loss of income due to a slowdown or a temporary suspension of normal operations stemming from damage to its physical property. Let's say a doctor’s office in Florida is damaged in a hurricane. The doctor is unable to see patients in that office until the building is considered to be structurally sound again. The business income coverage would kick in during the time period when the doctor's business is interrupted.