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Week of 5.22.09

Self-Employment: You Asked, He Answered

Brian C. Greenberg Certified public accountant and radio talk show host Brian C. Greenberg answers many of the questions we received in response to his special NOW feature "Financial Tips for the Self-Employed."

Read the questions and answers below.

Question: If you haven't had federal tax withheld from your earnings, do you need to file a federal income tax declaration if you owe no tax?

Brian Greenberg (BG): One should always file a federal income tax return. Filing starts the audit clock running and the IRS has three years to audit you (assuming you haven't committed fraud or understated your income by more than 25%). Not filing means there is no time limitation on an audit and the IRS can come back to you 20 years from now, if it likes.

Question: I run a prop business and do my own taxes using a popular software package. I have miscalculated the last five years of taxes and owe a pile of money, I think. Should I talk to the IRS first, or some local tax prep company, or a CPA?

BG: If you had to appear in court to defend yourself, would you ask the prosecutor for assistance, the judge or hire an attorney? The problem you have highlights the importance of employing a CPA to prepare your taxes. And to heap more bad news on you, you can only go back three years (to 2006) to amend your taxes. One last thing, before you hire a CPA, make sure to get references. Just because a person passed an exam—albeit a difficult one—doesn't mean he or she is competent.

Question: I am 58, self-employed, only work about once a week, and, after expenses, have about 400 dollars to pay in self-employment tax. Should I pay quarterly or yearly?

BG: The IRS and the state you reside in frown upon people in your situation paying their obligations yearly. They want you to send money in quarterly. In your situation, calculation is reasonably easy to do since your income is consistent. For those whose income fluctuates and you expect the income will be approximately the same as the prior year, take the total tax liability from 2008, divide by 4 and pay that amount each quarter. This is an opportune time to reach out to a CPA to fine tune this process.

Question: What tax benefits are there for self-employment and freelance work?

BG: No one can fire you. People assume there is more security working for a company. But as 8.9 percent (unemployment rate) and another 6 percent (reduced hours) have found out, there is more risk working for one employer. If you're self-employed and you lose a customer, you're still in business. Lose your employer or they decide to downsize—you're out on the street. Also, there is no limitation on how much money you can earn being self-employed.

By being self-employed one can deduct expenses like a portion of housing, dining (where applicable), and auto travel. One can also make larger retirement contributions (income dependent) than an employee.

Question: Are there ways for a self-employed person to purchase affordable health insurance?

BG: One option is to join a business chamber where they may offer group rates for their members. For example, the Freelancers Union offers health, dental, life, and disability insurance for the self-employed. Enter your zip code to find options where you live.

Question: Can a person operate a freelance business in his or her home if zoning forbids it?

BG: Zoning typically applies to people coming and going in your home. If all you are doing is working at a computer that is not an issue. But seeing people as part of your business will violate zoning and cause you problems. If you have this problem look for "executive centers"—operations where businesses can rent conference space, share secretarial support and have mail delivered there all for a fraction of the cost of traditional business rent.

Question: If I want to start a second career and I need to be trained for it, can my re-training expenses qualify for a tax deduction? Do I have to show a certain amount of income from this career to get other tax benefits?

BG: If you go back to school, you could be eligible for the Lifetime Learning Credit which is 20% of the cost of your education up to a max credit of $2,000 ($10,000 in school costs). This credit is income dependent—everything has a catch—meaning the Lifetime Learning Credit is phased out (gradually reduced) for those with a modified adjusted gross income (AGI) of between $48,000 and $58,000 ($96,000 and $116,000 for joint returns). Those with a modified AGI of $58,000 or more ($116,000 for joint returns) cannot claim the Lifetime Learning Credit. You do not have to show a minimum income in order to get the credit or other tax benefits.

Question: As a freelancer, what's the maximum amount you can earn and not pay any federal income tax?

BG: The question posed is not quite complete. There are two taxes that are paid on a federal 1040 return - income tax and social security tax. If you are employed, your employer withholds the social security tax and you the taxpayer are only subject to income tax. However, if you are self employed (freelance) you are subject to both taxes. The maximum amount of income one can earn before being subject to social security tax is $400. The $400 represents the money received less all expenses.

Determining the maximum amount of income earned before being subject to income tax depends on a number of variables such as whether the person is single, married, has a home (mortgage), etc. See a CPA to determine your situation.

Question: Do you still have to pay the self-employed social security tax even if you have no federal income tax due?

BG: The Federal 1040 includes taxes for income and social security tax (if you're self-employed). It is quite possible not to owe any income tax yet owe social security tax. Again kids don't try this at home, find a competent CPA. You'll thank me when you do.

Question: My business is seasonal such that peak sales occur in December, but the goods sold are paid for in January and February of the following year. Filing on a calendar year (as for sole-prop 1040C) with a steadily growing business creates an inaccurate picture of annual net profits and an unrealistic tax burden. The self-employment tax amounts to half the actual profits. How can I restructure my business to solve this dilemma—now, retroactively and in the future?

BG: In the old days, pre-1986 or so, the IRS would allow you to have a different fiscal year ending if you were a corporation. That changed and now everyone must file on a calendar year ending December 31. In your situation, the best way to resolve it is to pay your bills to your vendors around December 28. Having an extra 30 days to pay doesn't work since it creates an unrealistic tax burden.

Note: The answers provided by Brian Greenberg represent solely his opinion and do not represent the opinion of NOW or its producers, who bear no responsibility for them. These answers do not necessarily reflect knowledge on Greenberg's part of all factors relevant either to the circumstances of the questioner, or to circumstances experienced by others in their own situations. You therefore should consult with, and solely rely on, your own professional advisors before making any material financial or legal decision rather than on the answers provided here.
 
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