Business, other income, and adjustments
Self-employment income
Self employment income is reported on Schedule C, Form 1040 and earned by a trade or business that is operated by one person, a sole proprietor. Income earned from the use of your name, image and likeness (NIL) are also reported on Schedule C. An unincorporated business owned by a married couple is generally a partnership; if the spouses file jointly, both materially participate, and both elect not to be treated as a partnership, then it is a qualified joint venture. Sole proprietors are entitled to 100% of the net profits and liable for 100% of the net losses. Also, the owner is personally liable for all debts and lawsuits against the unincorporated business. The sole proprietor pays self-employment (SE) tax at 15.3%, applied to 92.35% (.9235) of the business’s net profit; the 12.4% Social Security part applies only to the first $176,100 of combined wages and net earnings for 2025, while the 2.9% Medicare part has no cap.
Form 1099-K reports payments for goods and services received through payment card companies, payment apps, and online marketplaces. A payment app or online marketplace (a third party settlement organization) must issue one only when a payee’s gross payments exceed $20,000 and the number of transactions exceeds 200. P.L. 119-21 retroactively reinstated this pre-2021 threshold in place of the $600 threshold enacted by the American Rescue Plan Act of 2021, so it applies to 2025. Payments made directly by credit, debit, or gift card are reported regardless of the number or amount. The threshold controls only whether a form is issued: income from selling goods or services is taxable and must be reported, on Schedule C for a business, whether or not a Form 1099-K is received.
Forms 1099-NEC and 1099-MISC. A business files Form 1099-NEC for each person other than an employee to whom it paid at least $600 during 2025 for services, including attorneys’ fees. Nonemployee compensation (box 1) is generally self-employment income, reported on Schedule C (or F) with Schedule SE; if it isn’t, such as income from a sporadic activity or a hobby, it goes on Schedule 1 as other income. Form 1099-MISC reports at least $10 of royalties and at least $600 of rents, prizes and awards, other income, medical and health care payments, and gross proceeds paid to an attorney. The recipient reports rents from real estate (box 1) and royalties (box 2) on Schedule E, and prizes, awards, and other income (box 3) on Schedule 1 as other income unless they are business income. Either form can report direct sales of $5,000 or more of consumer products for resale. The $2,000 threshold enacted by P.L. 119-21 doesn’t begin until 2026.
Wrong or missing forms. All income must be reported even if no Form 1099 is received. A taxpayer who receives an incorrect Form 1099 asks the payer for a corrected form; if it can’t be corrected, the taxpayer still files on time, reporting the correct amount, and keeps the incorrect form with the records that support the correct figure. For a Form 1099-MISC, the recipient instructions also say to attach an explanation to the return. A worker who believes they were an employee and can’t get the payer to correct a Form 1099-NEC reports the amount as wages and attaches Form 8919. Amounts on a Form 1099-K that were included in error (such as gifts or reimbursements) or that came from personal items sold at a loss are entered in the space at the top of 2025 Schedule 1; a personal item sold at a gain is reported as a capital gain on Form 8949 and Schedule D.
Statutory employees
A statutory employee is a type of independent contractor who is an employee for Social Security and Medicare tax withholding purposes, but federal income tax is not withheld from the employee’s pay. Statutory employees deduct related business expenses on Schedule C. Examples of statutory employees are full-time life insurance sales agents selling primarily for one company, drivers who distribute beverages (other than milk) or meat, vegetable, fruit, or bakery products, or deliver laundry or dry cleaning (as agents or on commission), home workers who work on materials supplied by the employer and return the completed goods to the employer, and full-time traveling or city salespersons. Statutory nonemployees are the reverse: direct sellers, licensed real estate agents, and certain companion sitters are generally treated as self-employed for all federal tax purposes, including income and employment taxes.
Clergy members and ministers
A licensed, commissioned, or ordained minister is taxed as a W-2 employee of the church, and taxed as a self-employed person for Social Security and Medicare. A person who performs ministerial services as an employee may be able to exclude from gross income the fair rental value of a home provided as part of compensation (a parsonage) or a housing allowance provided as compensation if it is used to rent or otherwise provide a home. The housing allowance is nontaxable and is usually shown in box 14 of Form W-2, but is subject to SE tax. A minister with an approved Form 4361 exemption, however, is exempt from SE tax on ministerial earnings, including the housing allowance. Form 4029 is a different exemption: members of recognized religious sects who are conscientiously opposed to accepting public or private insurance benefits file it and waive all Social Security benefits, and it doesn’t cover services as a minister.
Cannabis and illegal business income
The Internal Revenue Code has determined that all income, legal and illegal, is taxable and must be reported on your tax return. Income from illegal activities, such as embezzled funds or money from dealing illegal drugs, is reported on Schedule 1 (Form 1040), line 8z, as other income, or on Schedule C if it comes from the taxpayer’s self-employment activity. The Internal Revenue Code (IRC) §280E states that a business that traffics in Schedule I or II controlled substances may not deduct ordinary and necessary business expenses such as rent, utilities, and advertising. A cannabis business may still reduce its gross receipts by its cost of goods sold (COGS), since COGS is subtracted in arriving at gross income and is not a deduction section 280E disallows. Many states are regulating legal marijuana sales, but marijuana was a Schedule I controlled substance and illegal under federal law. The IRS reminds “businesses that traffic marijuana in contravention of federal or state law” that they are subject to the limitations of IRC §280E.
Other income
Scholarship, grants, and fellowships are nontaxable to the extent that the monies are used for tuition, books, and course-related fees. Books, supplies, and equipment (such as a computer) are excludable from taxable income only if they are required of all students in the course. Amounts used for room and board, travel, dormitory or off-campus housing, and food are taxable and must be included in income.
Gambling, prizes, and awards are taxable income. A prize or award received in goods or services is included at its fair market value; a prize the winner refuses to accept is not income. Many winnings are reported on Form W-2G and input onto Schedule 1 (Form 1040), line 8. Gambling losses, up to the amount of gambling winnings, are deductible as an itemized deduction on Schedule A and are not subject to the 2%-of-AGI floor. Expenses related to prizes and awards, however, are miscellaneous itemized deductions subject to the 2%-of-AGI floor, which are not deductible for any tax year after 2017 (the TCJA suspension was made permanent in 2025).
State and local income tax refunds are taxed under the tax benefit rule: a refund of an amount deducted in an earlier year is income only up to the amount by which that deduction reduced the taxpayer’s tax in the earlier year. A 2025 refund of 2024 state income tax is reported on Schedule 1 (Form 1040), line 1, only if the taxpayer itemized deductions for 2024 and deducted state and local income taxes. None of the refund is taxable if the taxpayer took the standard deduction for 2024 or deducted general sales taxes instead of income taxes.
A hobby is an activity carried on primarily for pleasure or recreation rather than to make a profit.
In general, hobby expenses are not deductible for tax years beginning after 2017 due to changes from the Tax Cuts and Jobs Act (TCJA), made permanent in 2025. Under this law, miscellaneous itemized deductions that were previously subject to a 2% of adjusted gross income (AGI) limitation have been suspended. Before the TCJA, hobby expenses were deductible to the extent of hobby income if a taxpayer itemized their deductions. Presently, taxpayers are not allowed to deduct any expenses related to the hobby to offset that income. Taxpayers will be taxed on the total hobby income, even if the activity loses money. Income from an activity without intent to make a profit is reported on Schedule 1 (Form 1040), line 8.
The IRS distinguishes a business from a hobby based on the taxpayer’s intent to make a profit. If an activity is run with the primary intent to make a profit, the IRS will generally classify it as a business. An activity is presumed to be engaged in for profit if it shows a profit in at least 3 of 5 consecutive tax years (2 of 7 for horse activities); otherwise the IRS may disallow the losses and treat the activity as a hobby. This will be discussed in detail in Part 2- Businesses.
Cancellation of debt income
If your debt is canceled, forgiven, or discharged for less than the amount owed, then the amount is taxable income. Lenders are required to send the taxpayer a 1099-C form if they cancel a debt of $600 or more. The form reports an identifiable event, such as the lender’s decision or policy to stop collection activity and cancel the debt. If a taxpayer can substantiate insolvency in the year that the debt was cancelled, then the amount of insolvency is excludable from cancellation of debt income. Canceled debt can also be excluded if it is discharged in bankruptcy or is qualified farm debt, qualified principal residence debt, or qualified real property business debt (debt incurred in connection with, and secured by, real property used in a trade or business).
Foreign earned income exclusion
The foreign earned income exclusion was created to avoid double taxation for Americans working abroad. Use Form 2555 to exclude foreign income from U. S. taxation. The exclusion applies only to earned income: wages or self-employment income for work performed in a foreign country. Income received from foreign source pensions, investments, gambling, or alimony does not qualify for the foreign earned income exclusion.
For the 2025 tax year, the maximum exclusion amount is $130,000. U.S. taxpayers must have foreign earned income, have a tax home in a foreign country, and meet these qualifications to claim the foreign earned income exclusion:
- U.S. citizenship or resident alien status. The taxpayer must be a U.S. citizen or a U.S. resident alien.
- Qualifying presence in a foreign country. This status is met by residing in a foreign country for a full tax year or having met the physical presence test by being present in the foreign country for at least 330 days within a 12-month consecutive period.
See foreign earned income exclusion for more information.
FinCEN
The Financial Crimes Enforcement Network (FinCEN), a Treasury bureau, receives the FBAR. Since March 2025, beneficial ownership information (BOI) reports are required only from foreign companies registered to do business in a U.S. state.
Adjustments to income
Adjustments to income are regarded as above-the-line deductions, meaning these expenses are deducted from a taxpayer’s gross income before the standard or itemized deduction, thus resulting in adjusted gross income (AGI). Popular adjustments to income include:
- Traditional IRA contribution
- Educator expenses
- One-half of self-employment taxes
- Student loan interest
- Penalty for early withdrawal of savings
- Health savings account (HSA) contributions the taxpayer makes directly (not through an employer), figured on Form 8889: for 2025, up to $4,300 with self-only or $8,550 with family high-deductible health plan coverage, plus $1,000 at age 55 or older; the HSA trustee reports contributions on Form 5498-SA and distributions on Form 1099-SA
- Self-employed health insurance premiums for the taxpayer, spouse, dependents, and any child under age 27 at the end of the year, limited to the business’s net profit minus the deductible part of self-employment tax and any self-employed retirement plan contributions attributable to it, and not allowed for any month the taxpayer could join a subsidized plan of an employer of the taxpayer or the spouse (or of a dependent or a child under 27)
- Alimony payments for court decrees established before 2019.
- Certain business expenses of Armed Forces reservists, qualified performing artists, and fee-basis state or local government officials, figured on Form 2106 (employees with impairment-related work expenses also use Form 2106, but deduct those expenses on Schedule A, not as an adjustment).
- Moving expenses of a member of the Armed Forces on active duty who moves under a military order because of a permanent change of station, figured on Form 3903. Only unreimbursed costs of moving household goods and personal effects (including storage for up to 30 consecutive days) and of traveling to the new home are deductible; meals are not, and a car can be deducted at 21 cents a mile for 2025. Moving and storage services the government provides, and dislocation and temporary lodging allowances, are excluded from income and can’t also be deducted. For everyone else the moving expense deduction has been suspended since 2018, and P.L. 119-21 made the suspension permanent.
Less common adjustments that used to be written in by hand now have their own lines under Schedule 1, line 24 (“Other adjustments”), including:
- Jury duty pay the taxpayer gave to an employer that kept paying salary during jury service (24a)
- Expenses of renting personal property for profit outside a business, deducted against the rental income reported on line 8l (24b)
- The nontaxable value of Olympic and Paralympic medals and USOC prize money (24c)
- Attorney fees and court costs for unlawful discrimination claims, up to the income from the action (24h), and for an IRS whistleblower award, up to the award included in income (24i)
- The foreign housing deduction from Form 2555 (24j)
The 2025 Form 1040 instructions say to leave line 24z, the remaining write-in line, blank.
For a full list of adjustment-to-income items, see the website here.
Modified adjusted gross income (MAGI)
MAGI equals AGI with certain deductions and exclusions added back (for example, the student loan interest deduction and the foreign earned income exclusion), depending on the tax benefit. The IRS uses MAGI to determine eligibility for traditional IRA deductions, Roth IRA contributions, education credits, the Child Tax Credit, and the Premium Tax Credit.
Ordinary income and capital gain income
Ordinary income is income that is taxed at the rate according to an individual’s own tax rate. The rates for 2025 range from 10% to 37%. Capital gain rates are imposed on sale of assets that were held for more than one year. Capital gain rates are generally 0%, 15%, or 20%, but collectibles gain is taxed at up to 28% and unrecaptured section 1250 gain at up to 25%.