The Profit & Loss (P&L) Statement
- Anthony J. Charles, EA
- Jan 24
- 7 min read
Updated: Feb 10
This article applies to any taxpayer with a business. From a part-time side-gig to the multinational corporation, each business requires a P&L covering the entire tax year in order to prepare their tax return. My tax firm specializes in tax compliance for small businesses, and each year, I get the same question from my clients: “What do I need for my taxes?” Each year, the answer remains the same: “Your P&L.” So, I am writing this article to refer to clients for whom this affects. Also known as an Income Statement, the P&L simply shows the revenues and expenses of a business over a period of time. For tax purposes, the period covers the entire tax year. January 1 to December 31.
Form 1099-NEC Misconception
One thing I hear (usually at the beginning of filing season) is “I’m still waiting for my 1099s.” The truth is that I do not use your 1099-NECs when preparing your tax return. I only use what’s on your P&L. For some reason, many taxpayers rely on their 1099-NECs to determine their revenue. If you are doing things correctly, your P&L should be a result of bookkeeping throughout the tax year. The only thing that I do with your 1099-NECs is add them up and make sure that your gross receipts are at least what has been reported on your 1099-NECs.
Another misconception is that you only need to report the income that is shown on your 1099-NECs. That is not true. 1099s are information returns that businesses are required to file when they pay another business $600 or more during the year (with exceptions and special rules, blah, blah, blah). If a company paid you less than $600, a 1099-NEC is not required to be filed. In many cases, required 1099s that should be filed are forgotten or neglected (most often by self-employed taxpayers such as yourself… hint… hint). By the way, the IRS has penalties for such oversights. The point is that you are required by law to report ALL revenue you receive (including the value of goods and services), regardless of whether it is reported on a 1099 or not. Do not rely on other businesses to do YOUR bookkeeping. Okay, so now you know that you need to report all revenue, whether or not you got a 1099 for it, let’s move on to what’s in a P&L statement.
Structure of a P&L Statement
Always start with adding up all your revenue for the year. You can categorize your revenue how ever you want. For example, if you were a fruit seller, you might break down your revenue into how much customers paid you for apples, oranges, and bananas. Add it all up. Now you have gross revenue. There are different names for it. When selling products, it’s called gross sales. When selling a service, it’s called gross revenue. The term gross receipts encompasses all sales and/or revenue and is what's used for tax purposes.
How do you handle sales taxes? Good question. In states that levy sales taxes, you do not recognize amounts charged for sales tax as your revenue. Sales taxes go directly to your balance sheet as a liability that you owe to the state, since you are just collecting their money. It’s not yours. Never was. So, it doesn’t belong on your P&L. In Hawaii, we have a general excise tax (GET) that is charged to businesses as a gross receipts tax. GET collected is simply treated as a markup on your product or service. Quickbooks Online does not do a good job handling Hawaii GET because it treats it as a sales tax. Fixing it requires making adjusting entries to the trial balance.
If you give refunds or discounts, you may have to keep track of something called a contra-revenue account. Gross receipts minus refunds or discounts equals net sales. Some businesses that sell or manufacture goods have a Cost of Goods Sold (COGS) to keep track of. COGS is easy to understand. If I purchase an apple for $0.50, then turn around and sell it to a customer for $1.50, then my sales revenue is $1.50, and my COGS is $0.50. Take net sales and subtract COGS, and you get gross profit (also called gross income). In case of the apple, my gross profit is $1.00. This paragraph may seem overwhelming, but it is just a description of basic accounting terms and examples of each. The good news is that service-based businesses do not have COGS to keep track of. COGS is also called Cost of Sales (COS).
Expenses (specifically, operating expenses) are the items that most small businesses have a hard time with. They are important because they are deducted from your gross profit, and whatever is left over is what you are taxed on. On a P&L, as well as on a tax return, your deductions are categorized into groups, and the totals for those groups are listed on your tax return. Common examples include Advertising, Bank Fees, Cell Phone, Repairs & Maintenance, Business Meals, Insurance, Interest, Supplies, Depreciation, Rent, Utilities, Wages, GET taxes, and even obscure things like Professional Dues & Subscriptions and Transaction Management. You can connect your business bank account to Quickbooks Online and code all transactions into each category. Sometimes, my clients will give me a spreadsheet and list their expenses by month. For example, Interest paid in January, February, March… December. That’s not needed for your tax return. Add up the Interest paid for the entire year. That’s all I care about.
After you total all the operating expenses and deduct them, you are left over with net profit or (loss). That is the magical number that you will pay taxes on. The key word is net. On the 2024 version of Schedule C (Form 1040), it is on line 31. The only things that I do not want you to include in your P&L for tax purposes is your deductions for business use of vehicles, home office, and depreciation. I need additional information on those line items so I can calculate how much you can deduct. You can put those items on your P&L, but I will not prepare your taxes using those numbers.
There are hundreds of categories of deductions that can chip away at your income and lower your tax bill. Any ordinary and necessary (that’s a legal term) business expense can be deducted. You can list entertainment expenses in your P&L, but I will not claim those as deductions because they are specifically not allowed. Put down the total amount you spent on business meals for the year. I will cut that number in half because only 50% of business meals can be deducted on your tax return. Client Gifts are limited to $25 per client.
P&Ls can look different, but they all have the same structure that I just described. I am going to provide you with three example P&Ls, so you’ll know what they look like and what you’ll need to do before tax time. Most businesses hire a bookkeeper specifically to create these P&Ls. If you have a complex business without bookkeeping, I highly recommend that you engage one to assemble your P&L. It will always be much less expensive than having your tax preparer do it instead. I put together a few P&Ls in my career, and in each instance the fees were higher for the bookkeeping than for the tax return preparation. By the way, you’ll need separate P&Ls for each real estate rental property.
Example P&Ls
The Excel file linked above contains three spreadsheets. The first one is for a small service-based business. Typically what you might see for a real estate agent, accountant, or photographer. Get used to the terms you will commonly see on these financial statements and the way they are organized. For example, notice how Travel Expenses are broken down into subgroups for Airfare, Lodging, and Meals. I did that on purpose. You’ll also notice that near the bottom of the statement, there are two sections for Other Income and Other Expenses. Those parts include income or expenses that are not part of the core business operation. For example, for our fruit seller, let’s say they sold their fruit stand. Since they are not in the business of selling fruit stands, we will put any gains or losses in those areas, as appropriate. If you sell any fixed assets, they will need to be dealt with separately. Keep track of them individually by using a Depreciation Schedule.
Look at the second tab titled Goods. That is an example P&L for a small business that sells tangible goods. The big difference is the COGS section. You need to keep track of your inventory in order to calculate your COGS. If you look at Schedule C (Form 1040), Part III is where your COGS is calculated and reported. That is why it is important to know the status of your inventory on the last day of the tax year. There are Point-of-Sale (POS) systems that do this automatically. Higher-tier versions of Quickbooks Online have functions for tracking inventory as well.
Finally, look at the third tab called Manufacturing. That is for a large manufacturing business. Large businesses usually call their P&L an Income Statement or Statement of Income. This is something you might see for a publicly traded C corporation. It has different accounting terms than small business P&Ls. Regardless, they all follow the same format: Revenue minus Expenses equals Net Profit. I even included the accounting format lines that are seen on these financial statements.
Summary
In conclusion, preparation of tax returns depends heavily on the business’s P&L statement. Despite its appearance, the tax return is a little more complicated than copying a P&L statement on to a tax form. Various tax laws need to be applied, which means that a company’s financial statements (books) may differ from their tax returns. But I always start your tax return with your P&L. If you want more information about P&Ls and other financial statements, then I recommend looking at earnings reports from publicly traded corporations. They are required to report quarterly and annual financial statements to the public, which can be viewed on the U.S. Securities and Exchange Commission (SEC) website called EDGAR (Electronic Data Gathering, Analysis, and Retrieval). Hopefully, this article will answer the question “what do I need for my taxes?”
Ideally, running your P&L report should occur monthly, quarterly, or semiannually. I recommend running it according to your state GET filing frequency. You can use the P&Ls to file your GET returns. For tax time, it is best to start putting your P&L together in December. That way, when the tax year closes, you can close your books and have your final P&L ready to go in January. Do not wait until you have all your 1099-NECs. Again, hire a bookkeeper if needed. Your tax preparer does not need receipts for your business expenses. You need to keep your own receipts to substantiate your business expenses if asked by the IRS. If you are a corporation or a partnership, then I will also need your Balance Sheet (another financial statement). We’ll save that for another tax blog.
