Woman bakes her way out of foreclosure

They say the way to a man's heart is through his stomach. Apparently it works with banks as well.

Angela Logan, a divorced mom of three in Teaneck, New Jersey, fell behind on her mortgage payments after a contractor left her with $50,000 worth of damage. Faced with a $2,559.54 bill in July and the threat of foreclosure on her home of 20-years, Logan got a sweet idea:

She asked friends and family to help her raise the money by purchasing her homemade "Mortgage Apple Cakes," at $40 a pop.

Everybody loves a good cake. And these must have been show-stoppers: what started out as an order for 42 such cakes, she's since gotten orders for nearly 500 more, including requests from as far afield as Iraq and Hong Kong.

When the Teaneck health department got wind of this, it informed her that she couldn't use her kitchen as a place of business. So the local Hilton hotel stepped in and offered its industrial-sized kitchen. I guess cake is something everyone can get behind.

Foreclosure thus averted, Logan did what any ordinary, apple-cake-lovin' American mom would do: she launched a business from her idea. She's now got a website (which looks pretty homemade itself) for her Mortgage Apple Cakes, with the legend: Fighting Foreclosures, one cake at a time.

Catchy. Here's hoping Logan manages to stay in this particularly sweet spot.

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Tracking Uncle Sam's spending

If you're bored with keeping track of where the money goes in your household, try out a relatively new government Web site that tracks where your tax dollars are spent.

USASpending.gov offers an easily digestible look into where the government is spending money, with current and historical spending broken down by grants, contracts and loans. It drills further down by breaking it down into congressional districts and by contractors.

For example, I was amazed to learn that the top government contractor so far in fiscal year 2009 -- Lockheed Martin Corp. at $20.36 billion -- has received more money from the federal government than the top assistance recipient -- $18.9 billion to the Department of Health Care Services.

I guess it's not surprising the the Department of Defense is getting more money than any other area, but it's still interesting to see it in colored pie charts and graphs.

Mandated by the Federal Funding and Accountability and Transparency Act of 2006, the site is an updated version of fedspending.org, a site I've used to find possible news stories.

As the data shows, it's a good time to be a defense contractor. And if nothing else, it makes keeping track of your personal expenses look easy. Very easy.

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Taxes and Freelancing

Here are some tips and strategies for thinking about your taxes. There are special circumstances that apply to freelance writers and other creative professionals, so I will highlight what you need to know to prepare your taxes and to avoid IRS investigations.

First, let me start with some fabulously great news. Being self-employed is quite possibly one of the best tax strategies available today. Other good tax strategies include being a landlord and being an investor. All three strategies have one thing in common: you are in full control of your tax situation, and you can reduce current income by any losses you have from freelancing, renting out property, or investing.

Second, let me tell you that the IRS is fully aware of the tax benefits of being self-employed. They are on the lookout for individuals who (1) have high wages, and a correspondingly high business loss, or (2) have business losses year after year. If you are in one of these situations, you need to start thinking about how to protect yourself in case the IRS audits or "examines" your tax return. We'll discuss that later on.

The basic tax planning strategy goes like this: reduce your taxable income, shift taxable income into nontaxable income, take advantage of tax credits, and pay the right amount of estimated taxes. Being a freelance writer immediately puts you in full control of your taxable income, which means that you can fully control how much taxes you pay. Not to be overlooked are special taxes you get to pay for being self-employed. We'll discuss Self-Employment Taxes and its impact on your tax withholding or estimated tax payments.

Step 1: Getting Organized
Step 2: Calculating Home Office & Depreciation
Step 3: Reporting Your Net Profit & Paying Your Taxes
Step 4: Much Ado About Nothing – or, how to protect your business losses
Step 5: Incorporating Your Business and Stategies to Protect Your Business Losses

All freelance writers and other creative professionals are considered "sole proprietors," unless they choose to have some other form of business. A sole proprietor is just another way of saying "self-employed," "independent contractor," or "freelancer." Income and expenses related to your self-employment is reported on your 1040, Schedule C (PDF). Taking a look at the Schedule C is helpful. You can also download the Instructions for Schedule C (PDF).

The first step to getting organized is to separate your freelance income from other types of income. Keep a record of all your business-related income. Your clients may send you a Form 1099-MISC in January or February to report total payments for the previous year. Form 1099-MISC is like a W-2, it is used to report income you received. The IRS also gets a copy of any 1099s. Your total business income on Schedule C Line 1 must be greater than or equal to the total amount of income reported on your 1099-MISC forms. If you report less income on your Schedule C than reported on your 1099s, you will get a computer-generated audit notice. (That is, the IRS computer matches up your tax return with information the IRS receives, and if there's a difference, you get audited.) The easiest way to avoid an audit is to report all your income, whether you received a Form 1099 or not.

The second step to getting organized is taking a look especially at the various types of business-related expenses you can report. I highly recommend you start tracking your business-related expenses using the same categories on the Schedule C form. You can track your expenses using envelopes to sort receipts, or using a spreadsheet program, or using a personal finance program such as Quicken. The most relevant categories of expenses for freelance writers include:

• Advertising – this includes business cards and web-marketing
• Insurance – for life, property & casualty, or business insurance. Do not include health insurance under this category.
• Other interest – credit card or loan interest, such as interest paid on your computer loan.
• Legal and professional services – such as fees your accountant will charge
• Office expense – anything other than routine supplies.
• Rent or lease other business property – rent paid on a writer's studio, for example
• Repairs and maintenance – repairing your computer, for example
• Supplies – routine office supplies like paper, toner, pens, pencils, notepads, etc.
• Travel – the cost of traveling to a convention, meeting, or business trip
• Meals and entertainment – the cost of business meals, but be careful not to go overboard
• Utilities –electricity, gas
• Other expenses – such as Dues & Subscriptions, Web development, and Business telephone expenses.

Most writers have things like a website, high-speed Internet connection, a computer, various software programs, and a small home office where they do most of their work. Writers will typically subscribe to various magazines, trade journals, or research tools. If your expense does not fit neatly into one the categories above, don’t worry. Just create a new category, and put it in Part V for "Other Expenses." We would put Dues & Subscriptions, Business Telephone, and Website Development under Part V.

Most writers invariably spend money on books, it's what we love most, and so it is natural that we buy lots of books. In order to be a business expense, the books must be a reasonable and customary expense given your profession. As a tax writer, it is reasonable that I would buy lots of books on taxation, running a business, and personal finance. Those would be allowable business expenses. Also allowable would be reference books such as dictionaries, thesauri, encyclopedias, and so forth. I would list this in Part V, Other Expenses. If you are writing book reviews, movie reviews, or any product that might be seen as a personal expense, just keep your receipts along with a printout of your review. That way the IRS auditor will see that your expense was clearly related to your business activity.

Health Insurance expenses. If you are self-employed and you pay for your own health insurance, then you can deduct the full cost of your health insurance premiums on your Form 1040, line 31. In order to deduct your health insurance expenses, you must have a net profit from your business. If you have zero profit or a net loss, you can still deduct the health insurance premiums. But instead of going on Line 31, you deduct them on Schedule A as a medical expense.

Claiming expenses for your home office. The home office is one of the best things about being self-employed. You get to convert a portion of your personal expenses into a tax-deductible business expense. But beware: your home office deduction will be reduced or eliminated if you have a small profit or a loss. Looking at the Schedule C, the home office expense goes on Line 30, right after your tentative profit has been calculated. You can claim home office expenses only if you have a tentative profit, and you can at most reduce your profit to zero by using the home office deduction. You cannot use your home office expenses to create a loss. Since most freelancers already have a loss, they will be ineligible to claim their home office expenses.

Figuring your home office expenses. Calculate your home office expenses using Form 8829 (PDF). You calculate the percentage of your total home expenses that are allocated to your business use. You may calculate the percentage in one of two ways. Percentage of square feet: measure the size of your home office, and measure the size of your home. The ratio of the two will yield your home office percentage. Number of rooms: count the number of rooms in your home. Your home office percentage will be 1 divided by the number of rooms.

Convert Your Home Office into a Regular Office. The limitation on home office expenses can be avoided if you rent an office space or writer's studio. That way your rent and utilities are included as a regular business expenses without regard to the home office limit. For example, let's say your significant other leases a 2-bedroom apartment. He can sub-lease one of the bedrooms to you for use as an office. The lease agreement must be in writing, must not violate the main lease agreement for the apartment, and the monthly rent must be at a fair market value, and you must make actual rent payments. You can now deduct your rent expense without limitation.

Accounting for Your Business Assets. Believe it or not, as a freelance writer you have a number of business assets. A business asset is any property with a useful life longer than one year and which is used to produce income. Thus your website, computer, software programs, and office furniture can all be considered business assets. You have two choices for accounting for these purchases. You can treat them as ordinary expenses and deduct the full cost of purchase in the year the property is bought, or you can treat them as capital expenses and spread out the cost of the purchase over a number of years. No matter which option you choose, you will figure your expense on Form 4562, Depreciation and Amortization (PDF). Now, don't let the word "depreciation" scare you. Depreciation means spreading out the cost of a big purchase over a number of years. That's all. If you want to take the full deduction in the year of the purchase, you want what's called a Section 179 deduction, and is calculated in Part 1 of Form 4562. If you want to spread out the cost over a number of years, you are "depreciating" your property and will calculate the amount in Part 3.

Depreciate or Section 179? Generally, you should calculate depreciation last. Calculate your profit or loss before deciding on how to depreciate your assets. If you have a profit, you will want to use whichever method (depreciation or Section 179) gives you the lowest profit. If you already have a loss before depreciation, you will want to depreciate. That way more of your expenses will be moved to the following years when you may need expenses to offset additional income. Depreciation is tricky to calculate, and moreover you need to "tweak" your depreciate based on the decision factors I just discussed. As such, prepare your taxes using a computer program so you can easily recalculate your depreciation amounts. Since most freelancers have business losses, I recommend that freelancers use normal depreciation methods for their business assets. That means, I recommend against taking Section 179 deduction or any "special" or "bonus" depreciation. If you plan to depreciate your assets, the following material is recommended reading: Tax Topic 704 Depreciation, Publication 946 How to Depreciate Property, and Depreciation from Publication 334 Tax Guide for Small Business.

You calculate your net profit or loss from your self-employment on Form 1040, Schedule C (PDF). The figure on Schedule C Line 31 gets carried to two places: your Form 1040 Line 12, and your Form SE Line 2. If you have a net loss, the loss reduces your taxable income and reduces your tax. Also, if you have a loss, you do not have to fill out Schedule SE.

The basic equation for a Schedule C, or another other business-related tax return, is income minus expenses equals profit. If the profit figure is a positive number, congratulations! You are one of the few self-employed people who made money as a freelancer. If the profit figure is a negative number, you have a business loss. Join the crowd. The vast majority of freelancers incur losses. A business profit increases your taxable income, and increases both your regular income tax and your Self-Employment Tax. The Self-Employment Tax, figured on Form 1040 Schedule SE (PDF), is 15.3% of your net profit and represents the Social Security and Medicare taxes owed on your business profit. As an employee (on a W-2), you only pay half of the Social Security and Medicare taxes (7.65%), and your employer pays the other half. As a freelancer, you are your own employer, so you pay both halves.

Most self-employed people get into tax trouble because of the Self-Employment Tax. You need to set aside money at least every quarter, or better yet every month, towards your Self-Employment Tax. Let's say you anticipate having a net profit of around $1,000. Well, your Self-Employment Tax would be ($1,000 x 15.3%) $153. If you divide that into four quarterly payments, you should be paying $38.25 every quarter to the IRS as an estimated tax payment. You should also calculate your anticipated regular income tax. If you are in the 25% tax bracket, the additional income tax on your business profit would be ($1,000 x 25%) $250. So you should set aside $403 ($153 + $250) over the course of the year towards your estimated taxes. Freelancers who fail to make reasonable estimates of their future taxes often end up owing at the end of the year. Paying a balance due can be a hardship for struggling freelancers. Protect yourself from tax troubles by planning ahead, and making a sincere effort to pre-pay your taxes.

I recommend all self-employed entrepreneurs to enroll in EFTPS, the Electronic Federal Tax Payment System. Once you are enrolled, you can make estimated tax payments by phone or by Web, with the payment debited directly from your checking account. It's like bill pay for your taxes. The nice thing about EFTPS, you can schedule payments ahead of time, and you can designate exactly where you want each payment to go.

If the net profit figure on your Schedule C is a negative number, you have a business loss. The vast majority of freelancers incur losses. This is how losses work.

First, your business loss reduces your total income. On Form 1040, your total income is calculated on Line 22. The loss also reduces your Adjusted Gross Income (Line 36), and Taxable Income (Line 42). As such, your business loss reduces your income tax. If you have a day job (on a W-2), this means you will get a bigger refund compared to someone who earned the same amount of wages but did not have a freelance side business.

Reducing your taxes in this way is an excellent tax strategy. In fact, many tax professionals have encouraged people with high incomes to convert their hobbies into "businesses" so they can have a loss to reduce their income. Not surprisingly, the IRS has caught on to this strategy.

There's no hard-and-fast method for distinguishing between a hobby and a real business just based on the tax return. After all, the tax return is just a piece of paper, and so there's no way to tell a legitimate business from a hobby apart except by using a rule of thumb.

Hobby Loss Rule of Thumb. If a business reports a net profit in at least 3 out of 5 years, it is presumed to be a for-profit business. If a business reports a net loss in more than 2 out of 5 years, it is presumed to be a not-for-profit hobby.

This rule of thumb places a huge burden of proof on newly formed businesses. On the one hand, the IRS expects new businesses to incur a loss. It is normal for a business to have a year or two of losses before becoming profitable. On the other hand, it is likely that a business could have several years of losses before ever making a profit. In fact, several such cases have been sent to the Tax Court.

If you cannot meet the 3-out-of-5 year rule (3 years of profits in a 5-year period), you can still prove your profit motive using the following nine factors:

1. You carry on the activity in a businesslike manner,
2. The time and effort you put into the activity indicate you intend to make it profitable,
3. You depend on income from the activity for your livelihood,
4. Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business),
5. You change your methods of operation in an attempt to improve profitability,
6. You, or your advisors, have the knowledge needed to carry on the activity as a successful business,
7. You were successful in making a profit in similar activities in the past,
8. The activity makes a profit in some years, and how much profit it makes, and
9. You can expect to make a future profit from the appreciation of the assets used in the activity.

This list is found in IRS Publication 535 Business Expenses

.

An audit to defend your business losses can be a very expensive audit. If you lose, the IRS will disallow the loss. Your business expenses will be limited only to the extent of business income (which means zero profit). And you will have to re-calculate your tax liability, often meaning that you will have to repay some of your income tax, plus penalties and interest. The audit may also be a waste of time and money, since you will have to spend time fighting the IRS and paying an accountant, instead of focusing on making money.

Nonetheless, defending your business loss is in your best interest, because creative professionals have succeeded in demonstrating a profit motive despite years and years of losses. First and foremost, you must carry on your freelance work in a very businesslike manner. This means keeping good records, keeping a business diary showing meetings with clients, deadlines, and projects, having business cards and a web site that promotes your business, and keeping a log of freelance gigs you apply for, and so forth. If you arrive at your audit armed with a daily planner showing all this information, it will be harder for the IRS to prove that you were just a hobbyist. In other words, convincingly demonstrate that you are in business for yourself, and you will succeed in defending your business losses against an IRS examination.

Protecting Your Business Losses By Incorporating

The hobby loss rule-of-thumb applies to sole proprietors filing a Schedule C. One of the surest ways to prove you are serious about doing business is to form some sort of separate business entity. Businesses are separate entities for tax purposes, and so setting up a business for your freelance writing will provide a way for you to separate your personal income and expenses from your business income and expenses. Incorporating your business in a formal way for you to separate your business activities from your personal activities. I discuss incorporating your business and protecting your losses in a separate article.

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How to not screw up your taxes

I thought I was doing everything right until tax season. That's when my tax prep software told me I owed thousands of dollars for my small - by all standards - writing business. Thousands I ... didn't exactly have. Sure, I'd been saving some money to pay the IRS, and I thought it'd be enough, but there I was, scrambling to find a hefty chunk of extra cash. About $2,000 extra.

I realized I didn't know as much as I thought I did.

More than 20 million businesses in the U.S. have no employees. Most are operated by independent contractors - and by all counts, that number is growing, as recently-laid off workers take the plunge into starting their own companies or stringing together freelance work. As you navigate the world of business licensing, marketing, and setting up that Web site or Twitter feed, don't forget to spare a thought for Uncle Sam.

My first mistake: Not saving enough throughout the year. "I think that setting aside money [each week] is an important, smart thing to do, but realistically, I don't think most people do that," says Kelly Phillips Erb, a tax attorney and a blogger at TaxGirl.com.

I tried to save. I'd heard the rule of thumb that says 30% to 40% of your gross income will go to taxes, and I dutifully set aside three-tenths of everything I earned ... until I looked at the account and realized I had thousands of dollars. No way could I need that much money!

I forgot - willfully, maybe - that W-2 employees have taxes withheld on each paycheck, so of course my tax bill as a self-employed person would be higher. I hadn't paid anything throughout the year, and it was all coming due April 15.

At least I wasn't alone. "There was one year where I took on a substantial contract," says Sherry Beck Paprocki, a Columbus-based writer who just co-authored The Complete Idiot's Guide To Branding Yourself. "When my tax bill rolled around, it was $8,000, and there went the front-porch reconstruction that we had planned for that year."

Second mistake: Misunderstanding estimated tax. The simplest way of thinking about it is this: W-2 employees "pay" tax every week through withholdings. Estimated taxes are "kind of the equivalent of your withholding," says Phillips Erb. If you don't pay estimated taxes, you'll be hit with penalties and interest.

Don't fall for the "wisdom" that says if you got a refund last year you don't have to pay estimated taxes this year. If you paid any tax last year - even if you got a refund - you owe estimated tax this year. The next federal deadline is June 15, and most states follow the federal calendar, but check with your own state's department of revenue.

But how? I'd tried the IRS's estimated tax worksheet and decided anything would be easier than filling out that form - another factor that led to my whopper of a bill in April.

"In 30 years of doing this, I have never, ever told an independent [contractor] to use the IRS tax worksheet. That tax form is confusing to every single indie that's out there," says June Walker, a Santa Fe, N.M., tax consultant who specializes in self-employment issues.

Instead, she recommends a simple approach: If you expect to owe more tax this year (because your business is growing, perhaps) than last year, pay what your total tax was last year, broken into four equal, quarterly installments.

Your last year's total tax includes tax you "paid" through withholdings at your job, if you're a newly-minted independent worker. As long as you pay 100% of your last year's bill (110% if your gross income was over $150,000), you won't owe any penalties come April 2010, but if you're earning more as an independent contractor than you did on a salary, you'll still have a tax bill.

For example, if you paid $1,000 in tax last year, as long as you send the IRS $250 every quarter, you won't owe any penalties even if you owe $2000 in tax this year. But you'll still have to come up with that extra grand in April.

My third mistake: Waiting until the last minute. E-filing your yearly tax return is easy - most tax prep software even walks you through it - but your first quarterly estimated tax payment is due on April 15, too.

I didn't realize the government uses a different system for online estimated taxes. EFTPS allows taxpayers to pay straight from a checking or savings account, like the high-yield, online account I had been using to stockpile cash for my taxes. I couldn't write a check straight from that account, but I figured I'd just debit the money.

But EFTPS takes about two weeks to activate after you register - the government needs to ensure you are who you say you are. Since I didn't have two weeks to spare, I floated a check from my regular bank account and hoped the funds transfer from my high-yield savings would arrive before the IRS cashed the check. It did, but I could easily have been slammed by bank overdraft fees and IRS penalties.

My fourth mistake: Being afraid to ask for help. "TurboTax is a tool," Walker says. "If you give one guy a hammer he can build the porch. Give another guy a hammer, and forget it - he's going to knock off his thumb."

Taxes are much more complicated for independent contractors and business owners than they are for traditional employees. If you need help, call in an accountant who knows the independent-worker laws inside and out. The money you spend on their fees may be offset by the time you save by not trying to master tax planning on your own.

I shelled out for TurboTax and spent hours poring over receipts and bank statements, but would I do that in 2010? I may be that person with the bruised thumb. I've got the credit card scars to prove it

Sales tax holidays coming soon: is your state offering one?

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The Upside: What Recession? Solutions for the New Economy

"I don't use the word recession," says gallery owner and art consultant Heidi McBride. "Any time I think about financial challenges I say 'I'm dealing with the new economy.' "

I couldn't agree more. For two years now the prognosticators have been like unrepentant drunks, promising us that we've hit bottom and that this time it really is going to get better.

Don't believe them. In the aftermath of a bull market all that's left is B.S.

But even though I'm one of the U.S.'s many underemployed, I'm not depressed. That's because I've already gone through denial, anger, and bargaining, and have finally moved on to acceptance.

The key is flexibility. Which is why, in addition to seeking work in other media (why else would the guy who can't balance his checkbook write for a finance site?), I've begun doing Recession Yoga. In just a few weeks I've mastered Downsizing Dog, Can't Afford Childcare Pose, and Bikram Meltdown. Supplemented, of course, with Head Tilting Tequila and Falling Down Drunk.

It doesn't earn me any money, but it's done wonders for my ass.

Others have chosen to stretch their businesses in new directions. Like Karen Kane, a travel consultant and owner of Paris by Design. When business began to falter last fall, did she pull out her hair, gnash her teeth and shake her fist at the gods? Probably. But she also adapted. Instead of focusing on once-in-a-lifetime excursions to the French capital for high-end clients, she zeroed in on affordable travel to "the next best thing to being in Paris--and at half the price."

Introducing Montreal by Design. Kane even went one step further by creating downloadable self-guided tours for only $14.95, including Cheap Eats Montreal, Montreal for Francophones and Montreal for Chocolate Lovers. I'm there as soon as she comes up with Montreal for People Who Forgot Their High School French.

If you've already downsized as much as you can, what about upsizing? A friend who owns a creative firm got really creative when he proposed teaming up with his competitors. That's right, his competitors. Now three regional firms will share staff, projects and overhead, allowing them to maximize profitability by pursuing larger jobs internationally. Oh, and saving their businesses from going under.

Lean times caused the world-renowned Oregon Shakespeare Festival to trim some of the fat out of its budget, but it's still trying to make some gravy. The festival has experimented with "dynamic pricing," charging a premium for shows that are selling out. "We've been doing dynamic pricing on the downside for years with discounts and two-for-ones," says festival executive director Paul Nicholson. But by adding just $4-5 per ticket for their most popular shows last season, the festival gained an additional $133,000.

OSF is also expanding the use of its current resources by developing "synergistic venture projects" with other theaters, whether it's jobbing out their costume department or marketing the software program they've developed for their state-of-the-art lighting system.

The name of this new LLC is OSF Solutions, an apt moniker because this new revenue source provides solutions for other companies as well as its own. Which is just one way to survive in the New Economy.

And that, my friends, is The Upside.

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Stimulus Rebate and Dependents

People claimed on another's return do not qualify for the Stimulus Rebate. When deciding if parents should claim their child for one last year, the Stimulus Rebate should be considered. There are no age limits on the Rebate that I am aware of. We often compare the total tax a family would pay two ways. With them claiming their child and without them claiming the child. This often occurs when children are of college age. The potential $600 that they could get, if they have enough income, should be considered when figuring who should claim the child, MAYBE.

Part of my uncertainty here is caused by what I call the 2008 Make Up filing. I expect that those who missed out on this May's payment will still have chance at getting it later. According to the IRS, "If you're not eligible this year but you become eligible next year, you can claim the economic stimulus payment next year on your 2008 tax return."

So, if a child aged 18 is claimed by their parents for 2007, can they next year when filing their 2008 return, in effect claim that they are entitled to their $600, because they actually claimed themselves on their 2008 return, the period to which the Stimulus Rebate is tied to? If this is allowed, the parents can benefit from claiming them for one more year, and they can get the rebate. This is different than the rule that says, dependents can't get the rebate. I am not offering an opinion about whether this will be possible? I am asking for my readers comments on it.

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