Going it alone in your career?
Planning can keep the taxman at bay
By Pat Curry • Bankrate.com

By all accounts, it was a bang-up year for Indiana-based freelance writer Julie Sturgeon. She made a significant transition, moving from writing articles primarily for local and regional markets to regional and national assignments that paid more money for the same amount of work. She also added photography to her portfolio of services. Business was booming, clients were happy and her income doubled over the previous year.

Her husband, meanwhile, was sweating bullets, anticipating that Sturgeon's success would result in a huge tax bill come April. And it would have, if Sturgeon hadn't been fanatical about keeping records and receipts. Every trip to the bank to deposit a check or to the photo lab to drop off film went in her mileage log; every receipt went in an accordion folder.

"I had (receipts for) $1.32 ice cream cones to kids who modeled for me," she says.

Toward the end of the year, Sturgeon and her husband assessed their tax liability again and decided that December would be a great time to do two things -- buy equipment for the business and make maximum contributions to two retirement accounts.

"It was a lot of money, but I was going to have to spend it anyway," she said. "I'd rather put in my pocket than give it to the government."

When the tax-time number crunching was done, Sturgeon's efforts yielded a $1,400 refund -- instead of the $6,000 tax bill her husband had envisioned -- that they rolled over into her first estimated quarterly taxes for the next tax year.

Tax experts would applaud her efforts, and encourage freelancers to take full advantage of the host of deductions that are available to them. In fact, the advice from many tax experts is that if you aren't a freelancer, you should be.

"Being a freelancer is one of the great tax shelters left," says William Raabe, director of accounting programs at Samford University in Birmingham, Ala., and author of the nation's most widely used taxation textbooks. "There really aren't that many deductions individuals can claim other than owning a home, having a child or giving money to charity. The idea people can get paid to do work they enjoy anyway and get a good tax break is pretty attractive."

Unlike employees, who have to meet a minimum level before they can start deducting their work-related expenses, freelancers can deduct any legitimate business-related expense. That can be anything from courses taken to upgrade their skills to golf games with clients to dry cleaning bills for clothes worn on business trips.

Another major difference from employees, though, is that the checks freelancers receive for their work don't have any taxes taken from them, which makes tax planning even more important.

Here are some of the top issues faced by freelancers, with suggestions from tax experts:

Define being in business: Eva Rosenbaum, an accountant in Encino, Calif., who hosts the Web site taxmama.com, points out the importance of the difference between a business (deductible) and someone with a really expensive hobby (not deductible).

Businesses have the licenses and certifications required for the profession, a personal investment in the business, and a separate business account for the money that comes in and goes out. It's a good idea for freelancers to have business cards, a separate business phone number, and a brochure or flier that describes their goods or services.

The business's corporate structure also lends credence to the claim, and there are good arguments for being a sole proprietor, an S-corporation, a C-corporation, and a limited liability partnership (but that's another article). An accountant can explain what makes the most sense for a freelancer's particular situation.

Estimated taxes: Rich Hellmold is a CPA in Natick, Mass., who hosts the tax channel for guru.com, a Net-based community for independent professionals.

"There's always a bunch of questions on estimated taxes," Hellmold says. "Do I have to pay them? When?"

The answers are: yes, and on April 15, June 15, Sept. 15 and Jan. 15. Failure to meet these deadlines will attract the attention of the IRS very quickly, and can result in penalties on top of the tax itself.

Home office deductions: You can have your business pay for such home-related expenses as the mortgage or rent, lights, water, maid service, etc., and deduct it on your taxes.

The experts disagree whether taking home-office deductions is a good idea.

In years past, claiming a home office was an audit flag. That's not true anymore, said Sandy Botkin, an attorney, and certified public accountant, and the CEO and principal lecturer of the Tax Reduction Institute. He says every freelancer who's eligible should take them.

"A new law in 1999 said if you render significant administration or management activities and you don't have another office, you qualify as long as you use a portion of the office exclusively for business," Botkin says.

That's the really big catch. If your kids use your computer for homework assignments, you're running off Little League fliers on the copier or you work out of a spare bedroom, it's not used exclusively for business.

Even if you do qualify, Hellmold said he doesn't think it's worth the hassle because the return doesn't justify the effort involved.

"It never works out to be much money," he says. "The big expenses are the mortgage interest and the real estate taxes and you get those anyway. I normally discourage people from taking it."

The other major issue arises when you sell your house. If the business is paying a portion of the bills and you take that as a deduction on your taxes, you effectively create two properties -- a residence and a business. Up to $250,000 of the profits on a home sale, $500,000 for a married couple filing a joint return, isn't taxed. A business doesn't enjoy that benefit. The profit on the portion of the house used for business will be taxed that year.

Cash expenses: Rosenbaum notes that many freelancers don't track their cash expenses very well -- and it's serious money out of their pockets and into Uncle Sam's.

"Cash expenses are usually two to three times what people estimated," she says. "Once you actually show all the deductions you have, it dawns on you what you've spent. I have a client who works on cruise ships. He's using cash and different foreign currencies. We mapped out what he spends on tips, meals and hotels between cruise ships. He picked up Quicken and a Palm Pilot. Now that we're tracking it, we're looking at probably $30,000 in cash expenses vs. the $10,000 we estimated."

Receipts help, but aren't required. The IRS has average per diem rates for various expenses. Good record keeping will suffice for things like tips, valet parking, cab rides and tolls.

Rosenberg says she found an easy way to keep receipts together while traveling.

"In the folder the hotel gives you or the envelope from the airline. I stick all the receipts in those," she says. "When I get back, I have everything in hand. If you're getting reimbursed by clients, you can submit it for reimbursement immediately."

Travel expenses: Botkin has this down to a science. So does Sturgeon.

"For every day you're on business travel, you can deduct 50 percent of your food, 100 percent of your lodging and 100 percent of dry cleaning, shoe shines, and tips, and you don't need receipts if it's under $75 per item," Botkin said.

As long as a freelancer intends to do business, the expenses are deductible. This means that a freelancer who goes on vacation can't hand some stranger a business card and write off the trip. But if he called prospective clients ahead of time and scheduled short business meetings on a majority of the days, that's business. Plus, weekend days can be deducted as long as business is sandwiched on either side.

Sturgeon knows that she doesn't even have to actually make money to deduct the trip. She sends out proposals for travel stories before she leaves on a trip. Even if every editor says "no," she can show her intent to do business.

Technically, freelancers don't even have to leave town to take travel deductions. If a new client is in town and there are evening meetings and breakfast meetings, it's a legitimate expense to spend the night at the same hotel.

"You are on travel status when you're sleeping overnight in a strange bed, and you're conducting business," Botkin said.

Entertainment: With a little forethought, freelancers can have a really good time at the government's expense. Botkin notes that freelancers can write off 50 percent of the cost of things like golf games, theater season tickets, movies and major sporting events. What's required is to take along a friend and "talk business preceding or following the fun within the same 24-hour day as the fun."

The bottom line is good record keeping.

For travel and entertainment, here are the bases that must be covered, courtesy of taxmama.com:

• Who -- name and company (spouses' and dates' meals may not necessarily be deductible).
• Business purpose -- was this to sell, buy, learn?
• Business relationship -- was this a potential client, a source of information or contacts, a supplier -- why is this business? Even if you don't sell anything to a potential client or prospect, you are entitled to the deduction. No salesperson closes every deal.
• Time -- either during a business meeting or right before or after a business function is acceptable, as are expenses accrued during a business event (a week-long trade show, for example).
• Place -- make sure the receipt shows the name and address of the entertainment facility or restaurant. Rosenberg says the IRS is used to people making these up, so annotate all receipts properly if the address is not preprinted on them.

Done on a daily basis, it only takes a few minutes. Sturgeon and her husband have computerized the accordion-file approach, and can see how they're doing at a moment's notice. They check their status about once a month -- at the very least every quarter when the estimated tax payment is due -- and adjust accordingly.

Botkin says it's the best investment a freelancer can make.

"You're looking at $10,000 to $40,000 in deductions for a minute or two worth of work a day," he said. "On a per-minute basis, I don't think there's a freelancer in the world who earns what that tax will save you. Plus, it's after-tax money so it's even better than a raise."

Pat Curry is a freelance writer based in Georgia
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-- Posted: Aug. 1, 2000