To do a profit and loss statement for taxes, you total the revenue your business earned during the period, subtract the cost of goods sold to get gross profit, subtract operating expenses and depreciation, and land on net income. That bottom-line figure is what carries onto your federal tax return. The work is mostly about getting each layer right and keeping the records that support it.
Pick Cash or Accrual Before You Start
Your accounting method decides when a dollar shows up on the statement, so settle this before you enter anything. Switching later requires IRS approval.
Under the cash method, revenue lands on the statement when payment hits your account and expenses land when you pay them. Invoice a client in December, get paid in January, and that revenue belongs to January. Most sole proprietors and small service businesses use cash accounting because it tracks how money actually moves through the bank.
Under the accrual method, revenue counts when you earn it and expenses count when you owe them, regardless of when cash changes hands. That December invoice is December revenue even if the check hasn’t arrived. Accrual gives a more accurate picture of profitability if you carry inventory or extend credit, but it takes more tracking.
Most small businesses can pick either method. A corporation or partnership can use cash accounting as long as its average annual gross receipts over the prior three tax years don’t exceed $32 million for 2026.1Internal Revenue Service. Revenue Procedure 2025-32 Above that line, accrual is generally required.
Pull the Records You’ll Need
Accurate numbers depend on complete records. For revenue, gather sales receipts, invoices, and any Form 1099-K reports from payment processors or online marketplaces.2Internal Revenue Service. What To Do With Form 1099-K Bank and credit card statements are your cross-check. For expenses, compile receipts for inventory, rent, utilities, insurance, and every other business cost, plus copies of any 1099-NEC forms you filed for contractors.3Internal Revenue Service. Publication 1099, General Instructions for Certain Information Returns
Reconcile your bank statements against your internal records before you start building the P&L. Duplicate entries, missing deposits, and forgotten expenses caught here save you from cascading errors down the statement. A separate business bank account makes this considerably easier.
Keep the underlying records too. The IRS requires you to hold onto documents supporting your return for at least three years after filing, and up to seven years for bad-debt or worthless-securities deductions.4Internal Revenue Service. How Long Should I Keep Records
Total Your Revenue
Revenue is the top line. Add every dollar earned from selling goods or services during the period. On the cash method, include only payments received. On accrual, include revenue earned even if you haven’t been paid.
Leave out sales tax you collected for state or local governments; that money passed through your business, it wasn’t yours.5Internal Revenue Service. Publication 535, Business Expenses Also exclude loan proceeds, owner contributions, and refunds you issued. You’re capturing money the business earned from operations, nothing else.
Calculate Cost of Goods Sold and Gross Profit
If you sell physical products, figure out what those products cost you. Cost of goods sold (COGS) covers direct costs of producing or acquiring what you sold: raw materials, wholesale inventory, manufacturing labor, and inbound shipping.
The IRS formula is straightforward. Take beginning inventory, add purchases and production costs during the period, then subtract ending inventory.6Internal Revenue Service. Publication 538, Accounting Periods and Methods The result is COGS. Service businesses with no physical inventory may have zero or very little to put here.
Revenue minus COGS gives you gross profit. That figure shows how efficiently the core business turns sales into money before overhead. A shrinking gross margin over time means production costs are outrunning your prices.
List and Total Your Operating Expenses
Operating expenses are what it costs to run the business beyond producing the product itself. Grouping them into clear categories keeps the statement useful. Common categories:
- Rent and utilities: lease payments plus electricity, internet, and phone.
- Payroll: gross wages plus your share of Social Security tax (6.2%) and Medicare tax (1.45%) under FICA.7Internal Revenue Service. Publication 15 (2026), Employers Tax Guide
- Insurance: general liability, professional liability, workers’ compensation.
- Marketing and advertising: campaigns, print, promotional materials, website costs.
- Professional fees: accountants, attorneys, consultants.
- Office supplies and software: from printer paper to cloud subscriptions.
Every expense you claim has to be “ordinary and necessary” for your line of work to qualify as a deduction.8Office of the Law Revision Counsel. 26 USC 162 – Trade or Business Expenses Ordinary means common in your industry. Necessary means helpful and appropriate, not indispensable. A graphic designer can deduct Adobe software; a plumber probably can’t.
Home Office
Space used exclusively and regularly for business qualifies for a home office deduction. The simplified method gives you $5 per square foot of dedicated office space, capped at 300 square feet, for a maximum of $1,500.9Internal Revenue Service. Simplified Option for Home Office Deduction The regular method requires calculating the business-use percentage of your home and applying it to mortgage interest, insurance, utilities, and repairs. More work, often a bigger number.
Vehicle Use
Business use of a personal vehicle can be deducted at the IRS standard mileage rate or by tracking actual expenses. For 2026, the standard rate is 72.5 cents per mile.10Internal Revenue Service. IRS Sets 2026 Business Standard Mileage Rate The actual-expense method covers gas, insurance, repairs, and depreciation, prorated by business-use percentage. Either way, keep a mileage log with dates, destinations, and business purpose.
Business Meals
You can deduct 50% of business meals where you or an employee is present and the meal has a real business purpose, like discussing a project with a client.11Office of the Law Revision Counsel. 26 USC 274 – Disallowance of Certain Entertainment, Etc., Expenses Entertainment expenses like sporting events, concerts, and golf outings are not deductible. Food bought at an entertainment event stays 50% deductible only if it’s purchased or billed separately from the entertainment.
Add Depreciation for Equipment and Other Assets
Equipment, vehicles, and furniture bought for the business generally can’t be deducted in full the year you buy them. Depreciation spreads the deduction over the asset’s useful life. It’s a non-cash expense that still belongs on the P&L because it reduces taxable income.
Under the Modified Accelerated Cost Recovery System (MACRS), computers and vehicles fall into a five-year category and office furniture and fixtures into a seven-year one.12Internal Revenue Service. Publication 946, How To Depreciate Property Off-the-shelf software is three-year straight-line.
Two accelerated options can change the picture the year you buy something significant. Section 179 lets you deduct the full cost of qualifying equipment and software in the year it’s placed in service, up to an annually adjusted limit. Under the One Big Beautiful Bill Act, 100% bonus depreciation is restored for most qualifying business property acquired and placed in service after January 19, 2025.13Internal Revenue Service. One, Big, Beautiful Bill Provisions Property acquired before that date but placed in service in 2026 qualifies for only 20% bonus depreciation.
Whichever route you use, the depreciation figure appears as an expense on the P&L even though no cash left your account that year. Skipping it overstates profit and creates a surprise at tax time.
Calculate Net Income
Net income is the bottom line. Take gross profit, subtract total operating expenses (including depreciation), then subtract any remaining non-operating costs such as interest on business loans. What’s left is your net profit or net loss for the period.
The finished statement should show the business name, the time period, and each layer of the calculation in order: revenue, COGS, gross profit, itemized operating expenses, net income. Whether you build it in a spreadsheet or export it from accounting software, the logic is the same. A reader should be able to trace revenue down to profit line by line.
One warning worth stating plainly. Deliberately falsifying a P&L used for tax purposes is tax evasion, a felony punishable by fines up to $100,000 for individuals ($500,000 for corporations) and up to five years in prison.14Office of the Law Revision Counsel. 26 USC 7201 – Attempt to Evade or Defeat Tax Honest mistakes are correctable; intentional underreporting is not.
Move the Numbers Onto Your Tax Return
The P&L is not the filing itself. Its figures map onto specific tax forms. Sole proprietors report business income and expenses on Schedule C (Form 1040); net profit or loss then flows to Schedule 1 and to Schedule SE for self-employment tax.15Internal Revenue Service. Instructions for Schedule C (Form 1040) Partnerships file Form 1065 and issue Schedule K-1s. S corporations file Form 1120-S. C corporations file Form 1120.
Each line on Schedule C mirrors a section of your P&L: gross receipts, cost of goods sold, and itemized expenses including advertising, insurance, rent, and depreciation. If the statement is built cleanly, Schedule C is mostly a transfer job. The trouble spots are the categories that don’t fit on Schedule C directly. Home office expenses go on Form 8829, vehicle expenses use Part IV of Schedule C, and depreciation runs through Form 4562. Clear categories on your P&L make those satellite forms much easier.
Save the final statement and every underlying record in a secure digital format. The IRS can audit returns up to three years after filing in most cases, and up to six years if income is underreported by more than 25%.16Internal Revenue Service. Publication 583, Starting a Business and Keeping Records
What the P&L Drives Beyond Income Tax
For a sole proprietor or single-member LLC, the net profit on your P&L determines more than income tax. It also determines self-employment tax, which funds Social Security and Medicare. The combined rate is 15.3%: 12.4% for Social Security on earnings up to $184,500 in 2026, plus 2.9% for Medicare on all earnings with no cap.17Social Security Administration. 2026 Cost-of-Living Adjustment Fact Sheet You can deduct half of your self-employment tax from gross income when calculating income tax.18Office of the Law Revision Counsel. 26 USC 164 – Taxes
Because no employer is withholding, the IRS expects quarterly estimated payments if you’ll owe $1,000 or more for the year. The 2026 deadlines are April 15, June 15, September 15, and January 15, 2027.19Taxpayer Advocate Service. Making Estimated Payments Missing them triggers an underpayment penalty with interest, which is why building a P&L each quarter is how you figure out what to send.
Pass-through businesses (sole proprietorships, partnerships, S corporations) may also qualify for a 20% qualified business income deduction under Section 199A. For 2026, the deduction begins to phase out for single filers with taxable income above roughly $202,000 and joint filers above roughly $404,000. Below those thresholds, the calculation is 20% of net qualified business income subtracted from taxable income. Above them, wage and property limitations start to reduce the deduction, and certain service-based businesses like law, accounting, and consulting lose it entirely at higher incomes. The QBI deduction doesn’t appear on the P&L itself, but it affects how much tax you actually owe on the profit the statement shows.