What Not to Report As Wages on Schedule C, Line 26

The purpose of this article is to help you understand the purpose of Schedule C, Line 26, Wages. Whether or not you have employees, if you are a Sole Proprietor, it is critical that you properly deduct expenses related to compensation.

The purpose of Schedule C, Line 26 is to deduct employee compensation. The IRS has labeled this line "Wages", but employee compensation includes not only wages paid to hourly employees, but also salaries, commissions and bonuses paid to employees. The key here is this: whatever you pay your employees should be reported on this line.

With that in mind, let's discuss what should not be reported on Line 26. First, never report payments to yourself, the Sole Proprietor. The owner of a Sole Proprietorship is never considered to be an employee of the business. Any payments you make to yourself out of the business (sometimes called "draw") are considered a withdrawal of profit, not employee compensation.

The other big mistake is to report independent contractor payments on Line 26. If you have people that provide services to your business as independent contractors, report those payments on Schedule C, Line 11, Contract labor. And if these people are truly independent contractors, there should be a written contract between the two of you. Furthermore, if you pay a contractor $600 or more in a calendar year, you are required to issue him/her a Form 1099-MISC to report the total annual amount of non-employee compensation.

One final comment: if you report any employee compensation on Line 26, you must file several employee-related payroll tax returns on a regular basis. The most common federal payroll tax forms include Form 941 (quarterly), Form 940 (annually) and Forms W-2 and W-3 (annually). You may also be required to file payroll tax returns at the state level for state unemployment tax and worker's compensation insurance, so be sure to check with your state for details on that.