Tax and Financial Planning for Freelance Editors
June 21, 2005
Speaker: Lillian R. Lea, EA
Forum organized by Christine Freeman
Notes by Rick Coykendall with Lillian Lea
"Lillian Lea comes with an encyclopedia of knowledge on tax law
in her head," said Bonnie Britt in the introduction to our June
forum where members and guests made use of seats at the library's
small café tables for a relaxed experience with a mind-numbing
Since 1974, Lea, a member of the California Society of Enrolled
Agents, has focused her tax practice on self-employed taxpayers
and small businesses. Enrolled agents are licensed by the federal
government to represent taxpayers before the Internal Revenue
Service. A taxpayer advocate, Lea also engages in legislative
activities. Her talk with us was not intended as tax advice. She
recommends conferring with one's own tax advisor to address
Health Savings Account
Though not approved in California, health savings accounts are
insurance products used to set aside a limited amount of pre-tax
money for medical expenses. Only those with high deductibles on
their health insurance are permitted to have them.
Flexible Spending Account
A flexible spending account allows you to put part of your pre-
tax wage (or salary) into an account for health-care expenses.
Unfortunately, it is not available to the self-employed.
For most of us, Social Security will not meet our entire need for
retirement income. Lea encourages her clients to contribute to as
many kinds of retirement plans as possible, and to consistently
make the maximum allowable contribution each year. Generally,
this is money that will not be touched until retirement age
because early withdrawal triggers penalties on top of taxes.
The simplest plans are Regular IRAs and Roth IRAs. Employees can
contribute to 401K, 403B, or 457B (depending on whether in
private industry, a non-profit, or government employment).
Self-employed people can have SEP-IRA, SIMPLE-IRA, profit-sharing
plan, and the new self-employed 401k plan. These are all easy to
use "cookie-cutter" plans with little or no added cost. Each has
different methods of calculating individual contributions.
Maximum contributions vary by plan.
The more complex plans require a pension administrator.
A Roth IRA contribution is not deductible at the time you make
it, but timely withdrawals are tax free. Because you pay tax on
money put in, the younger you are, the more valuable tax-free
withdrawals will be in the future. The Roth IRA is subject to
Contributions to a Regular IRA can be deductible or
non-deductible, depending on whether or not you have another
retirement plan. A regular IRA is the first plan many people can
First-Time Home Buyers
Some people want to cash in their retirement plans for a down
payment on a house but Lea said that may not be wise. By the time
they pay the penalty for early withdrawal (10% Federal and 2.5%
California) plus regular income taxes, raiding a retirement plan
can cost over 40% of the distribution in penalties and taxes. In
some cases, Lea said, it might be less expensive to borrow on a
However, if you qualify as a "first-time home buyer," you may be
able to withdraw up to $10,000 from your IRA toward the purchase
of a home. A first-time home buyer is defined as someone who has
not owned a home for two years.
There is a "Saver's Credit" for low-income people who make a
contribution to certain retirement plans, including IRAs. This
can make the contribution affordable, by not only saving the tax
for the deduction, but also getting the additional tax credit. An
IRA can be opened with as little as $50, depending on the
Progression of Retirement Plans
Once a year, you can move money out of an IRA to another
institution, but the rules are strict. It must be done in sixty
days to avoid penalty.
SIMPLE vs. SEP
Lea does not like the term "SIMPLE IRA" because an inexperienced
bank teller might sell you a regular IRA.
The government loves acronyms. SIMPLE stands for Savings
Incentive Match Plan for Employees. Employees may defer up to
$10,000 into a SIMPLE IRA for 2005 (limits change often), and
employers may be required to match the contribution, but only up
to 1% or 3% of wages.
Self-employed people have the same limit for a deferral, but they
can also put in the "employer" 3% contribution as well. They use
"Net Earnings from Self-Employment" for the calculation, which is
usually on Line 4 of Schedule SE.
You can't defer more than you earn.
SEP (also called a SEP-IRA) stands for Simplified Employee
Pension Plan. Employers (not employees) contribute to SEP-IRAs.
The self-employed can put up to 20% of "net self-employment
earnings" in a SEP. You cannot have both a SIMPLE and a SEP; if
you open a SIMPLE, you would have to close the SEP.
A SIMPLE must be opened by October 1 of the year in which you
contributing. A SEP, on the other hand, may be opened until the
extended due date of the tax year for which you want to make a
Entertainment is the most common category of tax deductions
people forget to take. If you discuss business over a meal, you
can take it as a deduction. But trying to deduct every meal won't
work. Any deduction must detail who, what, when, where, and why
it is business. Writing this information on your receipt is fine,
though you only have to keep the receipt if it's over $75. Under
that amount, you don't need to retain the receipt but you still
have to track the information on a calendar. Old calendars are
handy in the event of an audit.
Mileage is another valuable deduction too frequently forgotten.
Tracking mileage on MapQuest is easy. Click on
Directions, type in the "from" and "to" points; add your notes,
and file it.
Transportation costs via BART, or your parking fees, to attend
BAEF meetings may be deductible as business expenses.
Home Office Deduction
There's a persistent myth that taking a home office deduction can
trigger an IRS audit. In practice, Lea said, it mostly doesn't.
The "exclusive" rule still stands, however. You have to be able
to prove that your home office is used exclusively for your
business operations. It can be a corner of your kitchen, yes, but
you can't chop vegetables there.
Lea cited one case where a woman lived in a 400 square-foot
studio apartment and claimed an exclusive home office space. The
IRS said there was no way she could reasonably claim any
exclusive use in such a small space.
Many homeowners used to avoid taking a home office deduction
because of the complexity. But in 2002, the IRS changed the rules
on that and said even if you had the home office during the
entire time you owned the house, as long as it was not in a
separate structure, all you have to do when you sell the house is
pay tax on the depreciation taken after May 6, 1997.
Every town has its own rules for having a business license if you
are self-employed, and it seems the denser the population, the
more rules there are. Find out the rules in your city. Having a
business license has not been essential when it comes to proving
to the IRS that you're an independent contractor, Lea said.
A Sales Tax on Services?
As we shift from a retail to a service economy, efforts will
continue to try to tax services. Lea suggests we be alert for
this kind of legislation because editing may some day fall into a
proposed taxable category.
The problem for service businesses is that clients may decide to
take their business to a state (or country) without sales tax on
services, or may expect us to absorb the tax ourselves without
passing it on to them. Lea notes that all tax laws have become
increasingly complex over time. If you're doing your own taxes,
consider using a computer program, but know that programs are
only as good as the input.
For record keeping, many of Lea's clients use Quicken, a
computerized checkbook that can be helpful in categorizing income
and expenses. QuickBooks does more than Quicken but may not be
necessary for a small service business. While not a true
accounting program, QuickBooks has a definite learning curve, and
not everyone needs its level of complexity. You can use it for
invoices, but those in attendance who did not do a lot of
invoicing noted that setting up a template in MS Word was fine
for their purposes.
Lea praised the "hot topic" page on the IRS website
for background on many of the topics examined at this forum. She
also praised us, saying this audience of editors stayed with the
ins and outs of the complicated discussion much longer than most.