Gross Profit vs Net Profit on Schedule C: Which Margin to Price From

Gross profit is your net sales minus the cost of the goods you sold, and net profit is what is left after you also subtract business expenses. They are different numbers on Schedule C, so a shop can have a healthy gross margin and a thin net margin. In the IRS's own Publication 334 illustration, gross profit is 25.17% of net receipts. If expenses were $60,000 (an assumption added here), net profit would be 9.59%.

This post walks through how the IRS defines each figure and what that means for the margin you price from. For the margin and markup formulas themselves, see margin vs markup and why mixing them underprices.

1. How the IRS defines gross profit

Publication 334 says that for a business that sells products, you first figure net receipts: gross receipts (Schedule C line 1) minus returns and allowances (line 2) gives net receipts (line 3). Returns and allowances include refunds you give customers, rebates, and other allowances off the actual sales price. Then you subtract the cost of goods sold (line 4) from net receipts to get gross profit.

The publication stresses that you determine gross profit before you deduct any business expenses. Expenses come later, in a separate part of the form.

Here is the publication's retail illustration for the year ended December 31, 2025:

The cost of goods sold in that example is $37,845 beginning inventory plus $285,900 in purchases, minus $2,650 withdrawn for personal use, minus $32,955 ending inventory.

2. How net profit differs

Publication 334 chapter 9 says you find net profit by subtracting business expenses from business income. If expenses are less than income, the difference is net profit and it flows to Schedule 1 (Form 1040), line 3. If expenses are higher, you have a net loss.

The Schedule C instructions describe the last step for line 31: if gross income is more than your expenses and you have no prior-year unallowed passive activity losses, you subtract line 30 from line 29, and the result is your net profit. Line 30 is the home-business deduction. The instructions also say net profit goes on Schedule SE, line 2, for most sole proprietors, and the Publication 334 chapter on self-employment tax gives the 2025 rate on net earnings as 15.3%. So net profit is the number that the tax calculation uses, not gross profit.

3. The numbers side by side

Start with the IRS illustration and compute the percentages of net receipts:

• Cost of goods sold: $288,140 ÷ $385,060 = 74.83% of net receipts.
• Gross profit: $96,920 ÷ $385,060 = 25.17% gross margin.
• Markup on cost: $96,920 ÷ $288,140 = 33.64%.

Publication 334 does not list this shop's operating expenses, so the next step uses an assumption. Suppose the shop paid $60,000 in expenses such as shipping supplies, software, advertising, and fees. That figure is an example added here, not an IRS number.

• Net profit: $96,920 - $60,000 = $36,920.
• Net margin: $36,920 ÷ $385,060 = 9.59%.
• Expenses as a share of net receipts: $60,000 ÷ $385,060 = 15.58%.

So of each dollar of net receipts, about 75 cents went to the goods, about 16 cents to expenses, and about 10 cents stayed as profit before income and self-employment tax. The 25.17% gross margin looks comfortable; the 9.59% net margin is the figure that pays the owner.

4. Which margin should you price from

Use gross margin to set the price of an item, and net margin to judge whether the whole shop works. The reason is that gross margin is what each sale contributes toward paying expenses and leaving profit. Net margin only exists after the year's expenses are known.

A practical way to connect them, using the example above:

1. Pick the net margin you want, for example 15%.
2. Estimate expenses as a share of sales. The example shop's are 15.58%.
3. Add them: 15% + 15.58% = 30.58%. That is the gross margin the shop needs.
4. For an item that costs $10, the price is $10 ÷ (1 - 0.3058) = $14.40.

The example shop's actual gross margin of 25.17% would price the same $10 item at $10 ÷ (1 - 0.2517) = $13.36. The $1.04 gap on that one item is the difference between roughly 10% and 15% net.

The formula in step 4 is the same price-from-margin formula as in the margin and markup post. The only new input is expenses.

5. A check the IRS suggests

Publication 334 offers a test for retail and wholesale businesses: divide gross profit by net receipts and compare the result to your markup policy. If the two percentages are close, your gross profit figure is likely accurate. A large gap may mean errors in sales, purchases, inventory, or other costs.

The publication's example uses a shop that aims for a one-third gross profit on sales. With net receipts of $300,000 and cost of goods sold of $200,000, gross profit is $100,000, and $100,000 ÷ $300,000 is 33 1/3%, matching the policy.

Notice the wording: the publication calls the policy a markup "on its sales", but the test divides gross profit by net receipts, which is a margin in the sense used here.

6. If you sell services

Publication 334 says that when selling merchandise is not an income-producing factor, you do not have to figure cost of goods sold, and gross profit equals net receipts. Most service businesses fall in this group. For them the gap between gross and net profit is just the expense total.

7. Key takeaways

• Gross profit = net receipts minus cost of goods sold; net profit = business income minus business expenses.
• In the IRS illustration, gross profit is $96,920 on $385,060 of net receipts, a 25.17% gross margin.
• With an assumed $60,000 of expenses, net profit is $36,920, a 9.59% net margin.
• To reach a target net margin, add your expense share of sales to it and price from that gross margin.
• Net profit is the Schedule C figure that feeds your income and self-employment tax.