Revenue is the money your business takes in before any expenses are subtracted. It sits at the top of the income statement, which is why it is often called the “top line.” The figure that remains after you subtract costs is net income, or the “bottom line.” So when someone asks whether revenue is before or after expenses, the answer is before: expenses come out of revenue to get to profit, not the other way around.
That distinction matters because federal tax is calculated on net income, not on revenue. A business can post a large revenue number and still owe little or nothing in income tax if its deductible costs are high enough. Understanding what gets subtracted, and when, is the difference between an accurate return and an expensive mistake.
What Counts as Revenue
Revenue includes every dollar your business earns from its core activities before anything is taken out: sales of products, fees for services, rent collected, interest earned, royalties, and similar receipts. Federal tax law casts gross income broadly, covering compensation, business earnings, gains from property, interest, rents, royalties, and dividends, among other sources.1Office of the Law Revision Counsel. 26 USC 61 – Gross Income Defined
A high revenue figure tells you customers are buying. It does not tell you whether the business is profitable. A company can bring in millions and still lose money if its costs run higher. Revenue alone never tells the full financial story.
From Revenue Down to Net Income
The path from revenue to net income runs through several subtractions, in a specific order.
Step One: Cost of Goods Sold
If your business produces or resells physical products, the first subtraction is cost of goods sold (COGS). COGS covers the direct costs of producing or acquiring what you sell: materials, manufacturing labor, and shipping to your location. It does not include indirect costs like office rent or marketing. Revenue minus COGS gives you gross profit. Businesses that produce or resell merchandise must account for COGS separately on their returns; sole proprietors do so in Part III of Schedule C.2Internal Revenue Service. The Challenges of Business Income
Step Two: Operating Expenses
From gross profit, you subtract the ordinary operating costs of running the business: rent, utilities, wages, advertising, insurance, supplies, and similar items. Federal tax law allows a deduction for expenses that are both ordinary and necessary for your trade or business.3Office of the Law Revision Counsel. 26 USC 162 – Trade or Business Expenses An ordinary expense is one that is common and accepted in your industry; a necessary expense is one that is appropriate for your business.4Internal Revenue Service. Deducting Other Business Expenses It does not have to be essential; helpful and reasonable is enough.
Step Three: Interest and Taxes
Interest on business loans and business-related property taxes come out next. Depreciation on longer-lived assets like equipment and furniture is also deducted here, spread over the asset’s useful life rather than taken all at once.
What is left after all of these subtractions is net income. If the number is positive, the business earned more than it spent. If it is negative, the business had a net loss for the period.
When Revenue and Expenses Are Recorded
The order (revenue first, expenses next) is the same for every business, but the timing of when each shows up on your books depends on your accounting method.
Under the cash method, you record revenue when payment actually arrives and expenses when you actually pay them. Under the accrual method, you record revenue when you earn it (for example, when you deliver the product) and expenses when you incur them, regardless of when money changes hands. The accrual method follows a “matching” principle, pairing expenses with the revenue they helped generate in the same period.
Most very small businesses can use either method. Larger ones, generally those averaging more than $32 million in annual gross receipts, are required to use the accrual method. Whichever method you pick, you have to apply it consistently on your federal returns.
Why the Distinction Matters for Your Tax Bill
Federal income tax is calculated on net income, not on revenue. That single fact is why the ordering question is worth getting right: every legitimate expense you deduct lowers the figure the tax rate is applied to.
How that net income gets taxed depends on how the business is organized:
- Sole proprietors report business revenue and expenses on Schedule C, which flows onto Form 1040. The net profit is taxed at individual rates.5Internal Revenue Service. Topic No. 407 – Business Income
- Partnerships file Form 1065 but do not pay income tax at the entity level. Each partner receives a Schedule K-1 and reports their share on their personal return.5Internal Revenue Service. Topic No. 407 – Business Income
- S corporations file Form 1120-S and generally do not pay federal income tax themselves. Profits pass through to shareholders.5Internal Revenue Service. Topic No. 407 – Business Income
- C corporations pay tax at the entity level, a flat 21% on taxable income, and shareholders may be taxed again on dividends they receive.6Office of the Law Revision Counsel. 26 USC 11 – Tax Imposed
For sole proprietors, partners, and S corporation shareholders, 2026 individual federal rates run from 10% on taxable income up to $12,400 for single filers to 37% on income above $640,600.7Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 In every case, the rate applies to net income, not to gross revenue.
Sole proprietors and partners also owe self-employment tax on their net earnings. The combined rate is 15.3%: 12.4% for Social Security and 2.9% for Medicare. You owe it once your net earnings from self-employment reach $400 for the year.8Internal Revenue Service. Topic No. 554 – Self-Employment Tax The Social Security portion applies only to earnings up to $184,500 in 2026.9Social Security Administration. Contribution and Benefit Base The Medicare portion has no cap. Like income tax, self-employment tax is figured on net profit, so every deductible expense lowers what you owe.
Which Expenses Actually Reduce Revenue on the Return
Only allowable deductions move the number down. Federal regulations specifically list management expenses, commissions, labor, supplies, repairs, vehicle costs, travel, advertising, insurance premiums, and business rent as deductible items.10eCFR. 26 CFR 1.162-1 – Business Expenses Common examples in practice:
- Rent for office, warehouse, or retail space, plus electricity, internet, and phone service.
- Wages and salaries for services actually performed, including reasonable compensation you pay yourself if the business is a corporation.
- Advertising and marketing, including online ads and print materials.
- Business insurance premiums covering fire, theft, liability, and similar risks.
- Travel, meals, and lodging while away from home on business, so long as costs are not excessive.
- Office supplies and incidental repairs.
If you use part of your home exclusively and regularly for business, you can deduct a portion of your housing costs. The IRS offers a simplified method, a flat $5 per square foot up to 300 square feet ($1,500), and an actual-expense method that prorates mortgage interest, insurance, utilities, and repairs by the percentage of the home used for business.11Internal Revenue Service. Simplified Option for Home Office Deduction The space has to be used only for business; a guest bedroom that doubles as your office does not qualify unless you use it for inventory storage or a daycare.12Internal Revenue Service. Publication 587 – Business Use of Your Home
Some costs do not reduce revenue on your return, even if the business paid them. Fines and penalties owed to any government agency for violating civil or criminal laws are not deductible, which includes traffic tickets, environmental penalties, health code fines, and OSHA violations.13eCFR. 26 CFR 1.162-21 – Denial of Deduction for Certain Fines, Penalties, and Other Amounts Personal expenses, political contributions, and commuting between home and a regular place of business are also off-limits.
Treating a non-deductible cost as a business expense understates net income and, in turn, tax owed. That is the kind of discrepancy the IRS looks for. Keeping revenue on one side of the ledger and only allowable expenses on the other is the whole point of the exercise, and it is what turns the “top line” into a “bottom line” a tax return can stand on.