A contractor deposits $480,000, writes off $60,000 of receivables, settles a $150,000 note for $90,000, and reports a loss. Three separate rules decide what lands on the return.
Gross receipts are the first number on a business return, and the lines below build on them. Gross receipts are the total amounts a business takes in from selling goods and performing services, before subtracting any cost or expense. A sole proprietor reports them on Schedule C line 1, a partnership on Form 1065 line 1a, and a corporation on Form 1120 line 1a.
Returns, allowances, and price adjustments reduce gross receipts to net receipts. Here is how the common items are handled:
- When you give a customer a refund, or a credit for returned merchandise, subtract it from gross receipts. It is not an expense.
- Sales tax you collect for a state is left out of gross receipts when it is not included in receipts on the books.
- Payments of the kind reported on Form 1099-K and Form 1099-NEC are included in gross receipts, even when no form arrives.
Common mistakes
- Putting equipment sale proceeds in gross receipts. The machine was a business asset, not inventory, so a $45,000 machine sale belongs on Form 4797, not Schedule C line 1. Including it on line 1 inflates self-employment income by $45,000.
- Deducting freight-out as part of COGS. Freight-in, the cost of bringing goods to the business, is a COGS cost. Shipping to the customer is a selling expense. Swapping them changes gross profit and the 263A absorption base.
- Applying 263A to a small business. When average annual gross receipts are $31,000,000 or less, the uniform capitalization rules are off entirely. Candidates who compute an absorption ratio anyway land on an answer choice written to catch exactly that mistake.
Bottom line
- COGS formula: beginning inventory + purchases + labor + materials + other costs − ending inventory, with purchases net of supplier rebates and trade discounts.
- Freight-in, direct labor, and factory overhead are in COGS; advertising, freight-out, and office payroll are not.
- Uniform capitalization under IRC 263A applies unless average annual gross receipts for the three prior years are $31,000,000 or less; tax shelters never qualify.
- Loss limitation order: basis, then at-risk, then passive activity, then excess business loss ($313,000 single / $626,000 joint for 2025).
Exam shortcut
Read every business-income stem for three signals in order. First, a dollar amount arriving from a customer: ask "was this a sale of inventory or a sale of an asset?" Asset means Form 4797, and the Schedule C line 1 answer choice is the trap.
The full lesson (about 3,927 words, 26 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
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