Gross Profit vs. Net Profit

Gross profit is what your business keeps from sales after subtracting returns and the cost of the goods you sold. Net profit is what’s left after you also subtract every other business expense. If you’re a sole proprietor, IRS Schedule C works out both for you. Gross profit is line 5: gross receipts, minus returns and allowances, minus cost of goods sold. Net profit is line 31, which you reach after taking out your operating expenses and any home office deduction (IRS Schedule C). Gross profit tells you whether your pricing covers what you sell. Net profit tells you whether the business as a whole makes money, and it’s the figure that carries over to your tax return.

The formulas at a glance

These are the steps in Part I and Part II of the 2025 Schedule C, the latest version the IRS has released (IRS Schedule C).

Schedule C line	What it is	How it’s figured
Line 1	Gross receipts or sales	All your business sales
Line 3	Net receipts	Line 1 minus returns and allowances (line 2)
Line 5	Gross profit	Line 3 minus cost of goods sold (line 4)
Line 7	Gross income	Gross profit plus other income (line 6)
Line 29	Tentative profit or loss	Line 7 minus total expenses (line 28)
Line 31	Net profit or loss	Line 29 minus business use of home (line 30)

Gross profit: sales minus what you sold

Start with gross receipts. The Schedule C instructions say to report all income attributable to your business from all sources, including amounts shown on any Forms 1099-NEC, 1099-MISC or 1099-K you received (IRS). Subtract returns and allowances, such as refunds, rebates and other allowances off the sales price, to get net receipts. Then subtract cost of goods sold. The result is gross profit (IRS Pub 334).

Cost of goods sold is figured in Part III of Schedule C, lines 35 through 42. You start with inventory at the beginning of the year, add purchases (minus anything you took for personal use), cost of labor, materials and supplies and other costs, then subtract inventory at the end of the year (IRS Pub 334). Labor is usually part of cost of goods sold only in manufacturing or mining. Small retailers and wholesalers usually don’t have labor costs that belong there, and other labor costs can be deducted as selling or administrative expenses (IRS Pub 334).

Two simplifications help small businesses. If selling merchandise isn’t an income-producing factor for your business, as with most service businesses, you don’t have to figure cost of goods sold, and your gross profit is the same as your net receipts (IRS Pub 334).

If you do sell goods and your average annual gross receipts for the 3 prior tax years were $31 million or less and you aren’t a tax shelter, you can choose not to keep an inventory. You still need a method that clearly reflects income, such as treating inventory as non-incidental materials and supplies (IRS).

From gross profit to gross income

Some business income doesn’t come from your regular sales. Publication 334 gives interest on a business checking account, scrap sales, certain fuel tax credits and refunds, and recovered bad debts as examples. That income goes on line 6 and is added to gross profit, and the total is your gross income on line 7 (IRS Pub 334).

Net profit: what’s left after expenses

Part II lists your business expenses, from advertising and car expenses to supplies, utilities and wages. Line 28 totals them, and line 29 subtracts that total from gross income (IRS Schedule C). To be deductible, an expense must be both ordinary (common and accepted in your field) and necessary (helpful and appropriate for your business) (IRS Pub 334). Our guide to deductible business expenses covers what usually qualifies.

Expenses for business use of your home are kept separate and go only on line 30. Subtract line 30 from line 29 and you have net profit or loss on line 31. A profit goes on Schedule 1 (Form 1040), line 3, and on Schedule SE, line 2 (IRS).

A worked example with goods

This is a made-up example. Say you sell handmade candles as a side business and use these numbers for the year:

Item	Amount
Gross receipts (line 1)	$20,000
Returns and allowances (line 2)	$500
Net receipts (line 3)	$19,500
Cost of goods sold (line 4)	$7,800
Gross profit (line 5)	$11,700
Other income (line 6)	$0
Gross income (line 7)	$11,700
Total expenses (line 28)	$3,200
Business use of home (line 30)	$0
Net profit (line 31)	$8,500

The $7,800 cost of goods sold comes from Part III: $1,000 of inventory at the start of the year, plus $8,000 of wax, wicks and jars bought, minus $1,200 of inventory left at year end. The $3,200 of expenses could be things like market booth fees, advertising and shipping supplies.

A worked example with services

Also made up: a freelance designer has $30,000 in gross receipts, no returns and no cost of goods sold. Gross profit is $30,000, the same as net receipts. With $6,000 of software, equipment and other expenses, net profit is $24,000. For a service business like this one, the whole gap between gross and net profit is operating expenses.

Profit margin

A profit margin turns profit into a percentage of sales so you can compare one year with the next. The University of Cincinnati describes it as the percentage by which revenues exceed the costs of doing business. To find it, divide net income by revenue and multiply by 100. Gross profit margin, by contrast, looks at what’s left from product sales after cost of goods sold (University of Cincinnati).

IRS Publication 334 uses the same idea to check your numbers. If you run a retail or wholesale business, divide gross profit by net receipts and compare the result with your usual markup. A large difference may mean you didn’t accurately figure sales, purchases, inventory or other costs (IRS Pub 334).

In the candle example, gross profit margin is $11,700 ÷ $19,500 = 60%, and net profit margin is $8,500 ÷ $19,500, or about 43.6%. The designer’s net profit margin is $24,000 ÷ $30,000 = 80%. What counts as a healthy margin depends heavily on the kind of business.

Why net profit matters at tax time

Net profit is the number the IRS works from. You must pay self-employment tax and file Schedule SE if your net earnings from self-employment, which Schedule SE figures from your net profit, are $400 or more (IRS Pub 334). Keeping an eye on net profit during the year also helps you size your quarterly estimated tax payments. And the better your records, the easier it is to back up every line, so see how to track business expenses.