A sole proprietorship is a business that is an extension of its owner. As a sole proprietor, you are personally responsible for all your business's liabilities and debts. You must pay taxes on all its income. While you must report your business's income on your 1040, you tally the profits and losses of your sole proprietorship on Schedule C of the1040; you calculate the business's gross income in Part I.
Gather your records of your gross receipts. As a sole proprietor, you should keep financial records regarding your business activities. These records should include every sale you make, when you make it, and how much income you receive from the sale. To determine your sole proprietorship's income, you'll want to keep the business's sales activities separate from other forms of income you may have.
Keep all receipts for the raw materials and labor you use to create your product. Your business records should also indicate all purchases you make in relation to the business. These records should include what you purchase, when you purchase it, and the cost of all purchases.
Add up the sales revenue from your gross receipts. You only want the income you earned for the tax year. Generally, the tax year begins on January 1 and ends on December 31.
Subtract the value of all returns you had during the year and any allowance for returns from your sales revenue. The returns allowance is your estimated value of future returns on already sold product.
Subtract the cost of goods sold from your sales revenue. You calculate the cost of goods sold using your inventory amounts. Determine what the value of your inventory was at the beginning of the year. Add the value of all the materials and labor that went directly into creating the product. If you had a secretary who did not participate in creating the product, do not include her wages. Once you subtract the value of the inventory as of the end of the year what remains is your gross profit.
Calculate any other business income. Additional income can include any prizes or awards your business received, as well as profits you made from selling scraps.
Add your gross profit and other business income to determine your gross income -- which is not your taxable income. To determine your taxable income, you must subtract other permissible, deductible expenses, as well as other deductions, which you also calculate on Schedule C.