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Tax Planning

Moonlight With Less Tax

This month Kim highlights how to report extra income, who can collect full Social Security while working and if bonds are still a buy.

I picked up some extra work as a freelance consultant in 2008. How do I report income from self-employment at tax time, and can you suggest any strategies to keep taxes low? -- E.G.L., Lutherville, Md.

A few key strategies can help minimize the tax bill if you did freelance work in 2008 or started your own small business. First, when you file your 2008 tax return, you'll need to submit a Schedule C in addition to your Form 1040. You can use the shorter Schedule C-EZ form if you have business expenses of $5,000 or less, no employees and no home-office deduction.

If your net earnings are more than $400 for the year, you'll need to file Schedule SE to figure your self-employment tax, which includes Social Security and Medicare taxes. As both employer and employee, you'll owe self-employment taxes of 15.3% of net earnings, but you get to deduct half of that amount, using Schedule SE, on your 1040.

Each client should send you a Form 1099 reporting your 2008 income. That's where you'll find the information you'll need to complete your tax forms. For more information, see IRS Publication 334, Tax Guide for Small Businesses.

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You'll be able to write off many of the expenses from your freelance business, including the cost of a computer, printer, fax machine, copier and other equipment you use for work. Work-related phone calls and mailings, office supplies, copying, advertising, business travel and other expenses are also deductible.

Your health-insurance premiums may be deductible if you aren't eligible for coverage from an employer or your spouse's employer (you can't deduct more than the net income of your business). You may also be able to write off the business use of your home, including a portion of your homeowners insurance, utilities, rent or mortgage interest. The amount of these deductions is based on the percentage of your home used for your business. To qualify, you must use the space for work on an exclusive and regular basis, and your home office must be your primary place for conducting business or meeting with clients. For details, see the IRS Tax Topic on Business Use of Home.

If you aren't having any taxes withheld from your income, you may need to make estimated tax payments by submitting Form 1040-ES each quarter. Generally, to avoid an underpayment penalty, you should pay quarterly taxes if you'll owe more than $1,000 when you file your return.

Bet on bond funds?
I own several bond funds, including DWS High Income, Putnam Tax-Free High Yield, Van Kampen Government Securities and Vanguard Short-Term Investment-Grade. They all performed poorly last year. Will these funds ever recover their value? Or should I sell them and put the money into stock funds to take advantage of the anticipated market recovery? -- Milton Martin; Hopewell, Va.

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Last year was a terrible one for most kinds of bonds (the only big winners were Treasury bonds). And the lower the quality of the bonds a fund owned, the bigger the hit it took. That explains why your DWS fund, which invests in corporate junk bonds, and the Putnam fund, which invests in low-quality municipal IOUs, performed so poorly.

But the bond market started reversing some of these excesses late last year, and these funds have begun to recover. In the first five weeks of 2009 alone, the DWS fund gained 6.7% and the Putnam fund returned 7.8%. They won't advance at that pace for the entire year, but if the credit markets operate normally and the economy bottoms soon, there is a good chance that the funds' share prices will stabilize. That wouldn't be such a bad thing in light of their generous yields -- 13.1% for the DWS fund and a tax-free 6.4% for the Putnam fund.

Although the Vanguard fund is quite conservative, it didn't escape 2008 unscathed, losing 4.7%. It gained 1.9% in the first five weeks of 2009. It could eventually erase all of last year's losses, but don't count on it to generate big returns. The Van Kampen fund is a bit of a mystery. Just because it has "Government" in its name doesn't mean the fund owns only Treasury bonds. It also owns mortgage securities backed by troubled Fannie Mae and Freddie Mac. As a result, the fund lost 0.8% last year and 2.1% in the first five weeks of 2009. Given the low yields for government-backed bonds, a big advance doesn't seem likely.

As for whether you should sell your bond funds and buy more stocks, that depends on your time horizon, tolerance for risk and how the rest of your portfolio looks. As badly as bonds performed last year, stocks did worse. So to reach your desired asset allocation, you probably should be selling bonds and cash investments and buying stocksÑbut only if you have a strong stomach and plenty of time to reach your goal.

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Jobless-benefits basics.
I was laid off from my job, and I am wondering whether I can receive unemployment benefits. How do I sign up for them? M.G.; via e-mail

To qualify for unemployment benefits, you must be out of work through no fault of your own and be actively looking for a job. You apply for benefits in the state where you worked, even if you now live in another state.

File for benefits as soon as you lose your job so you don't miss out on any money. You normally receive your first check within three weeks of applying. But state unemployment offices have been inundated with requests for benefits, and it can be difficult to get through on the phone. To speed up the process, most states recommend filing online rather than on the phone or in person. Go to Career Onestop for links to your state unemployment-benefits agency.

The size of your weekly benefit varies depending on the state and your previous income (the higher your income, the higher your benefit). In Maryland, for example, the weekly benefit ranges from $25 to $380. Unemployment benefits are currently taxable, but taxes are not automatically withheld. You can elect to have taxes withheld from your checks, or you can set aside extra money so you aren't surprised by the tax bill later. And keep an eye on your state's unemployment-benefits Web site for updates -- several provisions in the federal stimulus bill could affect the length, terms and taxability of unemployment benefits.

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Penalty for working?
What are the rules for working and collecting Social Security? -- R.G.P.; Long Valley, N.J.

If you've already reached your full retirement age, you can work as much as you'd like without losing any Social Security benefits, no matter how much you earn. But if you haven't reached full retirement age -- which is 65 for anyone born in 1937 or earlier and increases to 66 for people born from 1943 to 1954 -- then your income could reduce your Social Security benefits. (See the list of full-retirement ages.

If you won't reach your full retirement age this year, you can earn up to $14,160 in 2009 without jeopardizing any of your Social Security benefits. You lose $1 in benefits for every $2 you earn over that limit. The income limit is higher in the year you reach your full retirement age.

If that happens in 2009, you can earn up to $37,680 for the months before you reach full retirement age without affecting your Social Security benefits, but you'll lose $1 in benefits for every $3 you earn above that limit. The limit disappears the month you reach your full retirement age. You can use the Retirement Earnings Test Calculator at www.ssa.gov to figure the impact of your earnings on your benefits.

If you do lose benefits to the earnings test, they are not lost forever. Your future benefits will be recomputed -- and increased -- based on the amount of time you went back to work.

Got a question? Ask Kim. Kimberly Lankford is the author of Ask Kim for Money Smart Solutions (Kaplan, $18.95).