Chances are you are receiving a computer-generated letter because the IRS thinks you owe it money. This is likely due to a mistake on your tax return, such as failing to include all your income. But the IRS is not always correct, so before you automatically pay the bill, do some investigation. It's very possible that the income from one or more W-2s or 1099s is being credited to your account in error. This could be the result of a simple bookkeeping mistake by an employer or, worse, it could be due to identity theft.
Even if the income is yours, the amount is correct, and you really did leave it off your tax return, double-check the IRS's work by adding the missing numbers to your return and recalculating your taxes. IRS computers often make mistakes and you might save some money.
You should also consider filing an amended 1040 form, and be sure to include any extra deductions for which the additional earnings make you eligible. If, for example, the new income was commissionable to an agent or manager, you shouldn't pay taxes on the 10 to 25 percent you paid in commission. But don't create phony deductions just to offset any additional taxes. If the deductions don't have a relationship to the new income, it may look suspicious to the IRS and prompt an audit.
Speaking of audits, the IRS seems to be targeting more performers than ever, and most of these examinations are being handled through what the IRS calls "correspondence offices." In such audits, you mail in all your receipts and records and you're not allowed to explain your deductions in person. Don't do this. Instead, ask for a transfer to a local office for a personal audit.
I never recommend the correspondence process for performers. The tax technicians in these offices are not as well trained in audit procedures as traditional IRS auditors are. They do not understand the specifics of the entertainment business and must follow bureaucratic policies that allow them to deny legitimate deductions. Although many people are told they must proceed with a correspondence audit, that isn't true. According to IRS Publication 1, you have the right to represent yourself.
If you have already been shanghaied into the process—even if you've already received the results of your correspondence audit—you should call the taxpayer advocate's office (listed in the paperwork the IRS sends you) and/or petition the tax court to appeal the decision. You can demand an appeals audit to overturn the inaccurate one.
All too many people simply pay the bills they are sent, believing it will end the crisis and get them off the IRS's hit list. Unfortunately, the result is often just the opposite. By paying the bill, the IRS believes you are admitting guilt, and so you become a target for future audits.
At a recent appeals audit I attended, brought on by the failure of the correspondence-audit process, the appeals officer began by saying that these offices shouldn't be allowed to audit performers, because they don't understand the entertainment industry. As a result, he said, the appeals offices are being inundated with cases, and he is personally working to change the system. At the end of the appeal, my client not only had the correspondence audit overturned; she also received an additional refund.
This result underscores my conviction that most IRS offices and employees genuinely care about providing you with fair and outstanding service. But you have to know and demand your rights, so that one or two bad apples don't mislead you.