Are you about to get audited by the IRS? Have you ever wondered why some tax returns are audited while others aren’t? The IRS doesn’t have enough personnel and resources to examine every tax return, so they rely on a variety of tools and systems to target returns that will generate the most revenue per hour for an auditor’s time.
As a performer, you don’t have the time to figure out how to play the game the IRS wants you to play. And even if you did, why would you want to? The key is to be careful up front!
Here are nine common miscues that may get you audited:
1. Your tax return doesn’t match reports sent to the IRS.
The IRS receives copies of 1099s, W-2s, and other documents reported about you using your Social Security number or other tax identification number. The number one reason you may be called into an audit is because the amounts reported on your tax return do not match with the information the IRS receives. Not only must the amount match, it must match to the proper form and line number of the form.
Actors and other performers receive W-2s for some of their work. But what if you get a 1099?
If you receive a Form 1099 for income you believe is incorrect, you should request the issuer to file a corrected form with the IRS. Unfortunately, some issuers refuse to correct the document, insisting that it is correct. If you were unable to get a corrected 1099, a competent tax professional can still make your tax come out correctly by reporting the incorrect amount on your tax return (to keep you under the IRS radar) and then make any necessary adjustments to arrive at the correct amount of tax.
2. Ignoring IRS inquiry letters.
With your busy schedule, running from audition to audition or from one gig to another, you may get behind on opening your mail. This could present a big problem! If you receive an IRS Notice, it is important that you answer it within the time window indicated. The IRS is giving you a chance to respond to what they think is an error on your tax return. If you are unable to explain why your tax return is correct to the satisfaction of the IRS, then you may find yourself embroiled in a full-fledged audit.
If your address changed, the IRS Notice may not have reached you. You may not know that you failed to show for your audit appointment and that you owe additional taxes. Your clue may have come when your bank or employer notified you of an IRS levy.
3. Deducting “reimbursable” employee business expenses.
Clearly, as a performer, you are juggling multiple responsibilities and you likely incur expenses that you never get reimbursed for, right? Are they deductible? It depends.
The IRS keeps a list of the larger employers who have an official Reimbursement Policy. IRS computers can match you to your employer through your W-2. If you deducted business expenses and work for one of these companies, then the IRS may want to talk to you in person. This happens quite frequently when you work for a big entertainment company that has a Reimbursement Policy you may not even be aware of. But the IRS is aware and their computers and systems are just waiting to catch you.
For the IRS, it’s a very low-cost way to collect money from taxpayers. It only takes some programming of their computers to find taxpayers who have W-2s from these companies and kick out a letter disallowing these business deductions you may have thought you could deduct.
The IRS disallows business deductions if you could have been reimbursed. If you were in an audit in this situation, the IRS would disallow ALL of your employee business expenses. The IRS assumes that if your employer did not reimburse you, then the expense must not be related to your job. Since most people in this situation would not know how to defend their deduction, they give up and pay the additional taxes.
There are strategies to minimize the damage. Most Reimbursement Policies do not reimburse all expenses and often the mileage reimbursement is less than the allowable IRS rate. In addition, I would argue that all of your expenses in excess of what would have been reimbursed by the employer should be allowed, since the employer would not have reimbursed them anyway.
Those in the entertainment profession may run up against one or more of these situations that can be a trap for the unwary. The IRS has rules that are strange and bizarre and if you don’t know how to play their game, you could very well lose thousands of dollars where you don’t have to.
4. Using round numbers on your tax return.
Using more than a couple of very round dollar amounts on your tax return is daring the IRS to audit you. The IRS computers are set up to find this method of “estimating.” They don’t believe that your office supplies added up to exactly $1,000 and your cell phone to exactly $1,200.
You can’t estimate your income and expenses; you must be able to support what is on your return with substantial documentation. However, if you do find yourself in a pickle because you did estimate, there are ways that a good tax professional could defend you.
And remember, “SALY” (Same As Last Year) doesn’t work either. The IRS is on to those who have the same amounts in the same boxes year after year.
5. Reporting cancellation of debt income incorrectly.
If you owe a debt and it is forgiven, the canceled debt may be reportable as income. This is a very complex area of the Tax Code, especially when it applies to real estate, but there are a few exceptions to it being taxable. You should also be aware that many of the 1099s reporting that information are frequently incorrect. Most people don’t know how to sort through the mess and fix the problem, thereby increasing their chance of an audit.
6. Failing to match gambling winnings and losses.
Gambling winnings are reportable earnings. You may deduct gambling losses against the winnings, but only if you itemize your deductions. Your gambling losses are limited to the amount of your winnings. Many people fail to report this correctly and are audited. For your deductions to hold up in an audit, you must be able to provide receipts, tickets, statements, or other records that show both your winnings and losses.
7. Incorrectly claiming charitable donations.
Everyone likes to be charitable, right? But even that can get you in the IRS crosshairs if you’re not careful.
The IRS will often audit tax returns with large charitable contributions. If your deductions appear to be disproportionally large compared to your income, or if you fail to file the correct supporting forms—or, worse yet, fail to properly complete the correct sections of the IRS forms—you are ripe for an audit.
In 2012, the IRS won a couple of big Tax Court cases. In one example, the taxpayers were denied over $20,000 in church contributions simply because their church did not include the phrase “no goods or services were provided” on the acknowledgment of the contribution. This is one of those cases that seems unfair, but then again, the Tax Code is not fair. The IRS is often allowed to trip you up over a technicality. In this case, the IRS acknowledged that the donation was, in fact, made to the church, but because the church failed to follow their requirement, the taxpayer was denied the donation. You would think that the IRS should have penalized the church for violating the rules. But they preferred to go after the easier target. The sad thing is that the Tax Court agreed with the IRS.
In another case, the taxpayers’ charitable donation of $18 million of real estate was denied, even though the IRS and Court acknowledged it was legitimate. The taxpayers again lost out on a technicality because they completed page two of Form 8283 incorrectly by not having a qualified appraiser sign the correct section of the form. The IRS and the Court acknowledged that the gift was, in fact, given to a qualified foundation, but it was denied over a procedure not being followed to the letter. Ouch!
Don’t think you’re immune. The IRS frequently denies even small charitable donations if the procedures are not followed. If you are audited, the IRS will automatically deny every monetary gift of $250 or more if you don’t have an acknowledgment letter from the charity for the amount of the donation, a description of any property donated, and whether the organization provided any “goods or services.” For non-cash charitable donations, you must be able to prove the condition of the items given and have support for the value of the item you are deducting. If your donation is worth more than $5,000, you need a qualified appraisal of the property and the appraiser’s signature on Form 8283, Section B.
8. Not understanding how IRS “DIF” scores work.
What’s that? A “DIF” score? When your tax return is filed, the IRS computers compare it against a database called the national Discriminate Information Function (DIF). That’s a very nerdy mouthful!
This score is based on averages in many categories such as income, family size, where you live, your occupation, and how you earn your money. If your tax return falls outside the averages, your DIF score rises, along with your chance of an unwelcome letter from the IRS letting you know you are being audited.
9. Not showing enough income on your return.
Yes, you read that right: not making enough income can draw IRS scrutiny. You can actually be audited for being too poor. I know, I said that three times because it seems so far-fetched but it’s true.
Many times, performers don’t get a W-2 (many times they do, I know); they get a 1099 and are considered “self-employed.” People who are classified as self-employed are being audited because the IRS believes they reported too little income and too many expenses. For example, let’s say you reported $30,000 in income for your “business.” The IRS will call you in because based on your occupation as a performer, your deductions, zip code, and family size, they have data reporting you need at least $49,000 to pay your bills. Therefore, you must have unreported income.
Unfortunately, the IRS computers do not account for a frugal lifestyle or non-taxable resources, such as child support, living off credit cards, savings, or help from family members. Since you did not report more income on your tax return, you are forced to do battle with the IRS because they may believe you are not being entirely truthful.
Ready for the big goof you could make if you are audited?
Representing yourself against the IRS.
If you actually believe you can take your records and receipts to an IRS audit and be treated fairly, you may be in for a big surprise. The government wants to collect the maximum possible from you and is willing to beat you up with technicalities in the law. They have tricks (techniques) up their sleeve to collect more taxes from you and to assess additional penalties. An example of one technique is the lifestyle audit: taxing you on the amount of income they believe you must have earned, but failed to report, based on your household lifestyle.
In addition, correspondence audits (audits done through the mail) are another technique. The IRS uses this method to frustrate you until you give up and pay the extra taxes and penalties. Further, they might create phantom income for you based on various databases. For example, when they see your occupation as “actor” or “singer” or “entertainer” or “comedian,” they will make up numbers based on others who put that on their tax return as their occupation. They won’t care that you may have gone several months of the year with no work or had gaps in your income. They randomly interpret this data as “proof” that you must be hiding income. And they may assess additional taxes and penalties based on a claim that you neglected to report certain income that was, in fact, accurately reported.
Based on my experience, about 50% (yes, that’s HALF) of the IRS notices I have seen are actually incorrect. But many people simply pay the bill, believing the IRS must be right.
Remember how I told you the IRS is tricky? Well, here’s one of the most common tricks they use: the auditor doesn’t tell you everything. Once you agree to the additional taxes for the year being audited, he or she will make the very same adjustments for the other two “open” years. This usually comes as a big surprise. The IRS auditor most likely did not disclose this before you signed the agreement to pay more taxes.
Let’s say that things weren’t going well for you in an audit and you just decide to bite the bullet and agree to an additional assessment of $4,000 for the year under audit. After signing the agreement, you learn that the IRS has made similar adjustments to the other two open years and suddenly your total tax liability is $12,000. Then, to make matters worse, the auditor adds an “accuracy” penalty, failure-to-pay penalty, and interest from the due dates of the original returns to the date of the audit. The total assessment could reach upwards of $16,000 or more. That’s not a bad return on investment for the auditor who may have put in only two or three hours of time ripping you to shreds.
A professional representative, such as an Enrolled Agent or a CPA, would have taken the IRS to task and required them to present you with their reasons for each assessment of additional tax. If you are audited, you need a representative who will be your advocate and stand up to the IRS.
Although there is no sure way to avoid an audit, choosing a skilled representative can save you money in taxes and penalties. It would be well worth it to hire a qualified professional to save you the time, grief, and substantial taxes, penalties, and interest.
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and do not necessarily reflect the opinions of Backstage or its staff.