January 14, 200

Announcements

Before the start of the presentation, Marguerite Langlois of the Steering Committee made the following announcements about upcoming events.

The March meeting will feature a website developer who enjoys working with small businesses and will provide practical information about creating or enhancing your website.

In April the Editors Guild will hold a half-day workshop on giving presentations and teaching.

The Guild is beginning preparations for its 2009 conference. The conference is held every two years. We are looking for committee members, specifically people with some experience putting on conferences. Many of the major structural decisions have already been made. We currently have two volunteers and need one or two more. We will meet once a month early on, with small tasks to be completed between meetings. Most communication will be by e-mail. Closer to the conference, there will be more work and we will invite more volunteers. Marguerite commented that even though the 2007 conference was a lot of work, organizing it was also a lot of fun. Anyone interested in volunteering should e-mail conference@edsguild.org.

Guest Speaker

Charlene Fleming, CPA E-mail: cefleming{at}keassociates[dot]com Phone: (206) 729-0795

Charlene Fleming is a CPA who specializes in working with small businesses. She holds an MA in accounting and an undergraduate degree in finance. In addition to her work as a tax advisor, she teaches QuickBooks at Bellevue Community College.

Charlene spoke to the Editors Guild five years ago and answered a lot of questions about taxes for self-employed people. Since then, she has helped many Guild members. She has been working with self-employed people for 15 years and stays abreast of the changes in tax law. She primarily tries to help small businesses figure out how to the traverse the troubled waters of taxes and stay out of the way of the IRS and the state while paying the least amount of money that is legally possible.

Part of Charlene's job is to help her clients figure out what is deductible. She does this in a 30-45-minute session, often at the client's own location. She tries to minimize stress about taxes and asks questions to figure out what else might be deductible that the client has not thought of.

During tax season, Charlene walks you through the steps and keeps you from getting hit really hard with what's coming up. During the non-tax-season, she educates people on how to keep their taxes down for the future, how to keep financial records, and other business issues.

Some of her major points included the following.

Tax Laws

Charlene pointed out that Congress passes tax laws, while the IRS merely interprets them. As a result there are a lot of gray areas until the IRS nails down rules with specific cases. Some people are very assertive about their taxes and try to write off too much, while others are very hesitant and, for example, don't write off their Internet service because they also use it for personal purposes. However, Charlene noted that she has never had the IRS say that you can't write off your entire Internet and cell phone bills, since those fees are not based on usage.

Charlene's job is to help her clients find their comfort level and understand what they are allowed to do. Her role is to communicate clearly all the possible deductions allowed and educate her clients about the future. For example, is it time to incorporate? Put money into a SEP or Roth SEP? Take a depreciation on the house? Buy a huge piece of equipment?

Business Licenses

Five years ago, if your earnings were below a certain amount, you did not need to have a business license or file tax paperwork. It used to be that if you earned less than $20,000 and did not have to charge sales tax, no license was needed. Now, the state wants freelancers to have a license, primarily to protect your clients.

For example, if you are a contractor working for Microsoft, the state's question is, are you really a freelancer or are you an employee who is just not getting benefits? The state's view is that anyone who is not clearly a business is an employee. Therefore the state can get unemployment and labor & industry payments for those people.

Even if you have always been a freelancer, the state now says that you really want to be an employee. If you don't have a business license, you are clearly not a business. If the state nails Microsoft and other customers, those companies will stop using freelancers.

The city of Seattle charges small businesses an annual licensing fee (currently $90, or $45 for businesses grossing $20,000 or less). If you get a state business license (a one-time $15 fee, or $20 if you register a business name), the city will find you.

Audits

What happens in an audit? Since freelancers generally don't face any sales tax issues, a state audit would primarily be concerned with whether you are paying the appropriate business and occupation (B&O) taxes on your non-W2 (1099) gross income. If the work was performed out of state bounds, you do not owe B&O tax. What matters is where you were doing the work, not where the client is located.

If you are doing just a small amount of freelance work, under $20,000-$22,000, the state small business credit will cover it and you won't owe any tax, though you may have to submit the form.

There are significant difference between the state and federal tax "monsters." In an audit, the federal government is pretty understanding and is generally very forgiving of small errors. The state, on the other hand, is not forgiving.

Freelancers probably only need to be concerned with the state Department of Revenue. State tax forms are due January 31, at which point you owe 1.5% of your gross taxable revenue. The state is tightening up and looking for revenue in all its governmental tax-producing entities. The governor's take is "we will audit small businesses for compliance." The number of auditors has increased, and therefore also the number of audits conducted. The state has set target figures for employee securities and labor and industry, though these are unlikely to apply to freelancers.

The Department of Revenue (the excise tax people) has doubled the number of auditors in the state, so the chances of getting audited have increased.

Charlene's sense of the general state of tax law and enforcement in Washington is that small businesses will bear the brunt, while large businesses get exemptions.

What can trigger an audit?

State level - Agencies have to meet targets and are looking for trends

IRS - random bad luck

Having lots of W2 income with a small amount of freelancing often tempts people to throw in all sorts of deductions and take a loss - doing this several years in a row may trigger an audit.

People who consistently take losses may not really have a business but an out-of-control hobby.

You must show a profit for three out of every five years to qualify as a business rather than a hobby. If you take a loss four years in a row, it doesn't mean it's not possible to qualify as a business, but you have a higher bar to jump. It's hard to convince the IRS if you are an editor who also makes a large W2 income.

Question and Answer Period

What if you're a freelancer with both 1099 and W2 clients?

This can be very good, since the W2 clients will pay Social Security, Medicare, etc. Then you can throw all your expenses at the rest of your income (1099).

The cost to a company of having an employee if more than just the salary. For example, $20/hour really costs the employer $22/hour, or roughly 10%, because of taxes, etc. This is why freelancers have to pay self-employment tax. When you go to do your taxes as a freelancer, they are often somewhat higher than expected because you are paying Social Security and Medicare, plus the matching portion that would be paid by the company if you were an employee.

Freelancers should try to include taxes in their pay negotiations to the best of their ability.

Deductions are extra important because every dollar you can bring your income down is also reducing your burden by approximately 15.3% tax on that amount.

You should set aside 20-25% of every paycheck for taxes. 25% is high; 20% is probably close, depending on your expenses.

If you can set aside that kind of money and pay taxes quarterly you will not have to write such a big check on April 15. If you do not pay taxes quarterly, you would have to write an even larger check to cover the interest on your unpaid taxes.

Should quarterly tax payments be the same amount each quarter or adjusted based on your income for that quarter?

The first option is safe-harbored, based on what you owed last year. As a broad generalization, if you take what you owed last year, divide it into four, and pay that amount each quarter, you can owe a million dollars in tax in April but will not have to pay interest.

The IRS quarters are illogical. 1st Q: January-March, due April 15 2nd Q: April-May, due June 15 3rd Q: June-August, due September 15 4th Q: September-December, due January 15

There is no logical reason why the second quarter is a two-month period

The state quarterly tax schedule is different and more logical: January-March, due April 30; April-June, due July 31, etc.

Who has to pay quarterly state tax?

This depends on "how big your ego was when you filled out your license application." Your tax schedule is based on your earnings estimate. Lower-income businesses pay annually. If you become a high-earning businesses, eventually the state may change you to a quarterly schedule.

City taxes are a duplicate of the state taxes, with a smaller percentage. You get a tax credit of up to $50,000 on your 1099 income. If you earn $50,001, you get no credit.

What about royalty income?

This depends on where your wrote the book you receive royalties for. Washington can only charge tax on book that you wrote in the state of Washington. There are interstate and foreign deductions for out-of-state books. In general, the tax on royalties is substantially smaller than that on other income.

If you don't want to show a loss, what is a reasonable profit to show?

$0 is technically not a loss, but too round a number looks suspicious. You will not owe self-employment tax on anything under a $400 profit.

What if you show a slight profit but did not pay self-employment tax?

Usually the IRS will figure that out for you and you will receive a CP2000 letter saying that your income doesn't quite match up.

It is better to be proactive than to wait for the IRS, because of penalties. It would also be good to show mitigating circumstances if possible.

The entire amount of your health insurance premiums are deductible on the front of your 1040 form. This also applies to COBRA payments. You can have W2 income as well and do not need to prorate, as long as your business was operating for the entire year.

Do state and federal governments talk to each other?

They are starting to. The IRS does not care about state numbers. During a state audit, the state will request copies of your federal tax forms from you.

What about planning for retirement?

There are two types of SEPs (Simplified Employee Pension plans) available, regular and Roth SEPs. These are similar to an IRA but based on a percentage of your bottom line on your Schedule C. You can set aside 20% of this bottom line into a SEP (not 25% as posted in some places, because of the self-employment tax).

You can have both a regular SEP and a Roth SEP (similar to a Roth IRA in you take no deduction when you put money in but pay no tax when you take it out).

You can contribute to both an IRA and a SEP if you are eligible for both, though you may be ineligible if you have too much W2 income.

IRA contributions must be made by April 15. SEP contributions can be made later if you have a valid tax extension, in which case you have until the extension runs out, though you will pay penalties and interest on your unpaid tax. You should pay your taxes by April 15 but you can file for an extension and not file your actual tax return until October if you need more time to contribute to your SEP. However, once you file the return you can no longer make contributions for that year.

Just as with an IRA/Roth IRA, your combined contribution to your SEP and Roth SEP cannot exceed the total amount allowed.

At what point should someone get professional tax help?

Hopefully any tax professional will come up with enough deductions and alleviate aggravation enough to make it worthwhile. Half the problem is trying to figure out the terminology. A professional will save both time and aggravation.

Charlene doesn't charge like the average CPA, many of whom charge $150-$200/hour. For the average person with W2 income, Charlene's services generally cost $150 or less, though if you call her on April 15, she will charge you more!