Tax Write-offs, Receipts and Audits

Our Actor's Tax Expert Shares His Tips

"AVOIDING THE "A" WORD-MINIMIZING YOUR CHANCES FOR AN AUDIT

DAVID ROGERS

APRIL 10, 2007

Audits are a dreaded phenomenon–and, I must add, deservedly so. An audit is always a bit frightening, even if you have the requisite records and receipts. If you don’t, it can create fear and trembling in the boldest and bravest of hearts.
Who gets audited? The answer to that is very different today than it was some years ago. Not too long ago, people with an annual adjusted gross income under $50,000. were about as likely to be bitten by a boa constrictor as they were audited.

But times have changed, and the current commissioner of the IRS is all about compliance–at all income levels. New auditors have been hired, and new criteria for audits have been designed, and lots of actors are feeling the sting an audit inflicts.

Audits happen in two general ways. The first is a random, computer-generated audit. This can happen to anyone, but is a generally rare occurrence. It comes about regardless of income, and regardless of any of the other criteria which generally prevail.

Apart from a random audit, the determination starts with something called a DIF score. This stands for Discriminate Function, and it is a computer program which identifies returns that have a high probability of error and a chance of significant tax change. The DIF score kicks out returns for analysis and this is where human subjectivity becomes operative.

If the analyst is knowledgeable about acting income, for example, he will know that it is not at all unusual for an actor to have deductible expenses that are at least a third of gross income. But if the analyst doesn’t know that key fact about actors, he may call for an audit.

The actual computer parameters that kick out returns for analysis are highly secret, known to only a few top IRS executives. But there are some strong indicators that can help you avoid audit.

Many actors are paid as independent contractors, and as we discussed, when that happens, we have to employ a form called a Schedule C. If expenses exceed profit on a Schedule C, the taxpayer is shielded from taxation on other income equaling the loss. But, a loss on a Schedule C–particularly a significant loss– is one factor we know increases DIF scores. So you want to be sure, if you show a Schedule C loss, that the expenses were applied properly, and that you have appropriate records and receipts.

Here’s another strong indicator that an audit may be in your future: your itemized deductions come to more than half your adjusted gross income. This criterion is not uncommon among actors, particularly actors with a middle-level income. Think about it–if you make $50,0000 a year and have an agent and a talent manager, those commissions alone will come to $12,500., and by the time you add all the other career expenses, plus state taxes, charity, etc., it’s easy for an actor to deduct that much.

Other factors that can precipitate an audit include extremely high business mileage, extremely high medical expenses, and–importantly for actors–high business entertainment expenses.

Once an audit happens, note that it can be either an in-person audit or a mail-in audit. Many actors feel that the mail-in is less stressful, but I think you give up important advantages. I recommend going in person, which is a right the IRS will grant.

Should you go yourself, hire a representative or take a representative? Like everything else in taxation, it depends. To avoid going yourself, your representative must be either the preparer who prepared that return, a CPA, an attorney or an Enrolled Agent (a designation awarded by the IRS to people who pass a grueling exam on tax issues). Any preparer can accompany a taxpayer to the audit, however.

There are certain basics to keep in mind if you go to an audit. Dress appropriately–nothing fancy, but businesslike attire. Show the auditor basic professional respect. You need not be obsequious, but if you are angry about being audited, remember the auditor is merely doing a job.

Have our records well organized, and your receipts and logs easily accessible. Auditors tend to think that performing artists will be scattered and unorganized, and when you come in like an efficient business person, their whole attitude becomes more conciliatory.

Remember, there is a whole series of safeguards built into your rights as a taxpayer, including appealing the results of your audit to an appeals officer, and even beyond that, taking your case to tax court.

Nothing is more important that having those all-important good records and receipts, particularly for large expenditures. Auditors value what they call contemporaneous documentation–documents from the time the expenses were incurred–much more than they do re-created documents.

Most actors never get audited. But for the increasing number who do, being well prepared can save big bucks and huge amounts of stress.