Introduction

The purpose of this publication is to provide general information about the federal tax laws that apply to small business owners who are sole proprietors and to statutory employees.

A sole proprietor is someone who owns an unincorporated business by himself or herself. However, if you are the sole member of a domestic limited liability company (LLC), you are not a sole proprietor if you elect to treat the LLC as a corporation. A statutory employee has a checkmark in box 13 of his or her Form W-2, Wage and Tax Statement. Statutory employees have to use Schedule C or C-EZ to report their wages and expenses.

To use this publication, you will generally need the following forms.

• Form 1040 and its instructions.
• Schedule C or C-EZ and its instructions.

See chapter 12 for information on ordering these forms.

Husband-wife business.   If you and your spouse jointly own and operate a business and share in the profits and losses, you are partners in a partnership, whether or not you have a formal partnership agreement. Do not use Schedule C or C-EZ. You must file Form 1065. For more information on partnerships, see Publication 541, Partnerships.

This publication does not cover the topics listed in the following table.

If you need information about:	You should see:
Partnerships	Publication 541
Corporations	Publication 542
S corporations	Instructions for Form 1120S
Farming	Publication 225
Direct selling	Publication 911
Commercial fishing	Publication 595
Recordkeeping	Publication 583

What you need to know.   Table A (shown later) provides a list of questions you need to answer to help you meet your federal tax obligations. After each question is the location in this publication where you will find the related discussion.

(Note: The following is a list of questions you need to answer so you can fill out your federal income tax return. Chapters are given to help you find the related discussion in this publication.)

Table A. What You Need To Know About Federal Taxes

What Must I Know	Where To Find The Answer
What kinds of federal taxes do I have to pay? How do I pay them?	See chapter 1.
What forms must I file?	See chapter 1.
What must I do if I have employees?	See Employment Taxes in chapter 1.
Do I have to start my tax year in January? Or may I start it in any other month?	See Accounting Periods in chapter 2.
What method can I use to account for my income and expenses?	See Accounting Methods in chapter 2.
What kinds of business income do I have to report on my tax return?	See chapter 5.
What kinds of business expenses can I deduct on my tax return?	See chapter 8.
What kinds of expenses are not deductible as business expenses?	See Expenses You Cannot Deduct in chapter 8.
What happens if I have a business loss? Can I deduct it?	See chapter 9.
What must I do if I disposed of business property during the year?	See chapter 3.
What are my rights as a taxpayer?	See chapter 11.
Where do I go if I need help with federal tax matters?	See chapter 12.

IRS mission.   Provide America's taxpayers top quality service by helping them understand and meet their tax responsibilities and by applying the tax law with integrity and fairness to all.

Comments and suggestions.   We welcome your comments about this publication and your suggestions for future editions.

You can e-mail us while visiting our web site at www.irs.gov.

You can write to us at the following address:

Internal Revenue Service
Tax Forms and Publications
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We respond to many letters by telephone. Therefore, it would be helpful if you would include your daytime phone number, including the area code, in your correspondence.

Important Changes for 2002

The following are some of the tax changes for 2002. For information on other changes, see Publication 553, Highlights of 2002 Tax Changes.

Self-employment tax.   The maximum net self-employment earnings subject to the social security part (12.4%) of the self-employment tax increased to $84,900 for 2002. For more information, see Self-Employment Tax in chapter 1.

Standard mileage rate.   The standard mileage rate for the cost of operating your car, van, pickup, or panel truck in 2002 is 36½ cents a mile for all business miles. See Car and Truck Expenses in chapter 8.

Credit for employer-provided child care facilities and services.   You can receive a tax credit of 25% of the qualified expenses you paid for employee child care and 10% of qualified expenses you paid for child care resource and referral services. This credit is limited to $150,000 each year. For more information, see Form 8882, Credit for Employer-Provided Child Care Facilities and Services.

Credit for small business pension plan startup costs.   If you begin a new qualified defined benefit or defined contribution plan (including a 401(k) plan), SIMPLE plan, or simplified employee pension, you can receive a tax credit of 50% of the first $1,000 of qualified startup costs. For more information, see Form 8881, Credit for Small Employer Pension Plan Startup Costs.

New credit for New York Liberty Zone business employee.   The New York Liberty Zone business employee credit is the result of expanding the work opportunity credit to include a new targeted group of employees in the Liberty Zone. You can claim the credit if you pay or incur qualified wages to a Liberty Zone business employee. The credit is for wages paid or incurred to new and existing employees for work performed during 2002 or 2003. For more information, see Form 8884 and Publication 954, Tax Incentives for Empowerment Zones and Other Distressed Communities.

Special depreciation allowance.   You can take a special depreciation allowance (or Liberty Zone depreciation allowance) for qualified property (or Liberty Zone property) you place in service during 2002. The allowance is an additional deduction of 30% of the property's depreciable basis. For more information, see Publication 946, How To Depreciate Property.

Increased section 179 deduction for enterprise zone businesses.   If you placed section 179 property in service in an empowerment zone during 2002, you may be able to increase your section 179 deduction by as much as $35,000 (up from $20,000).

For information on empowerment zones and enterprise communities, see Publication 954.

Increased section 179 deduction for businesses in the Liberty Zone.   If you placed section 179 property in service in the New York Liberty Zone during 2002, you may be able to increase your section 179 deduction by as much as $35,000. For more information, see Publication 946.

Health insurance deduction for the self-employed.   For 2002, this deduction is 70% of the amount you paid for medical insurance for yourself and your family. For more information, see Insurance in chapter 8.

Tax shelter disclosure statement.    You must file a disclosure statement for each reportable tax shelter transaction in which you participated, directly or indirectly, if your federal income tax liability was affected by the transaction. For more information, see the tax shelter disclosure statement discussion in the Schedule C (1040) instructions.

Important Changes for 2003

The following are some of the tax changes for 2003. For information on other changes, see Publication 553, Highlights of 2002 Tax Changes.

Health insurance deduction for the self-employed.   For 2003, this deduction is 100% of the amount you paid for medical insurance for yourself and your family. For more information, see Insurance in chapter 8.

Self-employment tax.   The maximum net self-employment earnings subject to the social security part of the self-employment tax increases to $87,000 for 2003.

Section 179 deduction.   For 2003, the total cost you can elect to deduct under section 179 of the Code is increased to $25,000. For more information on the section 179 deduction, see Depreciation in chapter 8.

Standard mileage rate.   The standard mileage rate for the cost of operating your car, van, pickup, or panel truck in 2003 is 36 cents a mile for all business miles.

Reportable transactions.    New disclosure rules require you to file Form 8886, Reportable Transaction Disclosure Statement, to report certain transactions entered into after 2002. Reportable transactions include (1) transactions the same as or substantially similar to tax avoidance transactions identified by the IRS, (2) transactions offered to you under conditions of confidentiality, (3) transactions for which you have contractual protection against disallowance of the tax benefits, (4) transactions that result in losses of at least $2 million in any single year or $4 million in any combination of years, (5) transactions resulting in book-tax differences of more than $10 million, and (6) transactions with asset holding periods of less than 45 days and that result in tax credits exceeding $250,000. For more information, see the Instructions for Form 8886.

Important Reminders

Accounting methods.   Certain small business taxpayers may be eligible to adopt or change to the cash method of accounting and may not be required to account for inventories. For more information, see Inventories in chapter 2.

Photographs of missing children.   The Internal Revenue Service is a proud partner with the National Center for Missing and Exploited Children. Photographs of missing children selected by the Center may appear in this publication on pages that would otherwise be blank. You can help bring these children home by looking at the photographs and calling 1-800-THE-LOST (1-800-843-5678) if you recognize a child.

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