For sole proprietors, business income other than what you receive from your customers in the ordinary course of business is reported on Line 6 of Schedule C. If you're filing Form C-EZ, you will include this income in your total on Line 1.
What kinds of income should be included here? Well, two common types of income that are not included are your gains or losses from sales of capital assets, which are reported on Form 4797, Sales of Business Property, and any gains or losses from casualties or thefts, which are reported on Form 4684, Casualties and Thefts.
Another type of income that might be considered business income but that must be reported on a different tax form is rental income from real estate, including personal property leased with real estate. This income is reported on Schedule E, Supplemental Income and Loss, unless you are a dealer in real estate, a hotel or motel operator, or your business is focused on renting personal property (e.g., formalwear or power tools).
Investment income. Income such as interest and dividends from bank accounts, stocks, and bonds are generally not considered business income for a sole proprietor, even if you think of them as reserve funds for business downturns. Instead, they are treated as personal items to be reported on Schedule B, Interest and Ordinary Dividends, which is part of your Form 1040. Any gains or losses on your investments are reported on Schedule D, Capital Gains and Losses.
One exception would be the situation where your business uses an interest-bearing account (for example, a money-market sweep account used in conjunction with your regular checking account). In that case, the interest paid should be reported on Line 6 of Schedule C or Line 1 of the C-EZ.
If you are in the business of lending money or if you are paid interest on notes receivable that you were given by your customers, you would report that interest income on your Schedule C or C-EZ. Dividends you received on business insurance policies should also be reported there.
Recaptured depreciation. If you need to report recaptured depreciation because your business use of expensed business equipment or listed property (e.g., cars, computers, cellular phones and other property generally used for recreation) dropped to 50% or less, you would report that recaptured deprecation on Line 6 of Schedule C, after computing the amount on Form 4797, Sales of Business Property.
Royalties. Royalty income you receive on property that you produce as part of your business (for instance, if you're a freelance writer and you receive royalties on a book you wrote) would be considered business income to be reported on Schedule C. But if you receive royalty payments on property you purchased or inherited, the payments should instead be reported on Schedule E, Supplemental Income and Loss.
Recovery of items previously deducted. If, this year, you recover some item that you deducted in a prior year (such as a state tax refund or, for accrual method taxpayers, a recovery on a previously deducted bad debt), you should recognize the amount as income in the current year. You don't need to go back and amend the previous year's tax return.
However, if the original deduction did not reduce the amount of income tax you owed for that previous year (for instance, if your net income was too low to expose you to taxes), you don't have to include the amount. If this exception applies to you, you should attach a statement to your tax return explaining how you came to your conclusions. This is especially important in the case of tax refunds, since they are reported to the IRS by the taxing body.]
Damages. If you receive compensation because of a breach of contract or fiduciary duty, patent infringement, or antitrust injury, the amounts must be included in your gross business income. This rule applies to punitive damages as well. You may be entitled to a deduction against this income for legal fees and other expenses you had to pay in order to recover the amounts.
Two other areas you may have questions about are: