Running your own business can be complicated, especially when it comes to taxes. Let's go over what the business tax definition is and how your can prepare for it.
The business tax definition is exactly what it sounds like: a tax on business income. The new tax laws starting in 2018 reduce the business tax to a flat 21 percent. This rate is for all corporations but sole proprietors and so-called pass-through businesses may pay more.
You don't have to show a profit every year to qualify as a business. As long as your primary purpose is to make money, you should qualify as a business (even if you show a loss when you're first starting out, and even afterward, depending on the circumstances).
Your business can be conducted from home, full-time or part-time, as long as you work at it regularly and continuously. And you can have more than one business at the same time. However, if your primary purpose is something other than making a profit‚ for example, to incur deductible expenses or just to have fun‚ the IRS may find that your activity is a hobby rather than a business.
The IRS may consider your business a hobby under a few circumstances. This can happen if your activities are primarily meant to incur losses or to have fun.
To avoid the hobby loss rule, you need to be able to convince the IRS that you engage in your activity primarily to earn a profit. It's not necessary that you earn a profit every year. All that is required is that your main reason for doing what you do is to make a profit.
The IRS can't read your mind to determine whether you want to earn a profit. And it certainly isn't going to take your word for it. Instead, it looks to see whether you do actually earn a profit or behave as if you want to earn a profit. It uses two tests to make this determination: the profit test and the behavior test.
If your venture earns a profit in three out of five consecutive years, the IRS presumes that you have a profit motive. The IRS and courts look at your tax returns for each year you claim to be in business to see whether you turned a profit. Any legitimate profit‚ no matter how small‚ qualifies; you don‚t have to earn a particular amount or percentage. Careful year-end planning can help your business show a profit for the year. If clients owe you money, for example, you can press for payment before the end of the year. You can also put off paying expenses or buying new equipment until the next tax year.
If you keep incurring losses and can't satisfy the profit test, you by no means have to throw in the towel and treat your venture as a hobby. However, you must be prepared to show the IRS that your behavior is consistent with that of a person who really wants to make money. There are many ways to accomplish this.
First and foremost, you must show that you carry on your enterprise in a businesslike manner. For example, you:
You should also draw up a detailed, professional business plan with forecasts of revenue and expenses, showing that you plan to earn a profit some time in the future. This single item can itself avoid a finding that by the IRS that your activity is a hobby. It will also be helpful if you try to borrow money for your business.
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