As an actor your expenses are almost entirely "Job Search" activities, including
any payments to your agents or managers--unless
are on a series or under a regular contract.
Arguably understanding the audit process of the IRS is the second important aspect of tax preparation. Although the IRS only audits about 2% of those who send in returns and therefore your chances of receiving an audit may appear to be less than 1 in 50, if you itemize deductions on your return and if you are “aggressive” with your write-offs, those odds increase substantially.
Our clients almost always come out of an audit with no additional charges. A big part of that is our ongoing dialogue with the client throughout the preparation process. We consider the educational aspects of the preparation process a priority. The clients must understand what are allowable deductions and the validity of the numbers they put into our tax packet.
In order to keep our fees low our standard rates do not include an “audit guarantee;” but we are available to assist you if you are informed that your return is selected for examination. One of the principle reasons we do not include an “audit guarantee” is simply because so few of our clients are audited and to raise our fee for the sake of the few that do get examined wouldn’t be fair to the rest.
So when we are asked to assist those who have received that dreaded letter, whether they are our regular clients or those who have worked with outside preparers, we have to charge additional fees.
The most difficult aspect of an audit, above the sheer terror that accompanies receiving the letter, is simply the time and effort trying to get all of your records into order, especially when the audit is usually two years after you filed. Most of us have trouble remembering what we were doing last week without some effort.
If you have properly prepared your taxes you should already have most of this work accomplished. If you can validate your write-offs and if the areas you included in those deductions are legitimate under IRS rules, you shouldn’t have anything to be concerned about. Seriously. That’s why training and instruction on how to keep your records and understanding what deductions are allowed by the IRS is a regular part of our preparation process.
On the other hand, most of the "horrific" cases we come across occur when we are asked to assist those who had their returns completed by a preparer outside our office.
Here then are some points we suggest you all consider.
Keep your records for at least five years. Many of our associates keep theirs longer. If you have stock sales or have made improvements on your real property you own (your house), then keep those records until you either sell the stock or your property.
When you choose to throw out your records, we suggest keeping the actual return and actual W-2's and other income statements you have received forever (or as long as you can). They can be of significant assistance when the time comes to double check your pension and/or Social Security payments.
Let’s cut to the chase. What are the chances of getting audited?
Here are some examples using the public records regarding audits from 2009. In that year there were 142,823,105 individual tax returns filed (versus additional corporation and employment income tax returns.)
Of that amount, 1,581,394 were examined or roughly 1.1% of the total filed.
Of the total individual returns filed, 16,052,553 (about 11.24% of the total individual filers) used a Form 2106 in their tax returns to report their expenses. This is the form most actors use in their tax returns. This then is the group we need to consider.
Of the 16,052,553 only 190,746 or about 1.2% were contacted for an examination. Obviously this is a higher amount than the average of 1.1% in the overall individual returns. On that basis then you can estimate that if you use a Form 2106 in your tax return each year you stand at least a 1.2% chance of being audited. That’s not all that bad—in general.
So why then do we hear of so many actors and performers being audited? The answer is because if you are pursuing a performing career you are spending considerable amounts of money and you are writing those expenses off on a tax return—far more so than the average tax payer. Most importantly the amounts we write off on the 2106 are significantly greater than most other “employees.”
Most actors today have both an agent and a manager and are forced to pay out up to 25% of their gross income from performing BEFORE they take a dime home, let alone pay for the balance of their remaining acting costs. Adding all the expenses an actor may incure, it isn’t at all uncommon for a working actor to be paying out forty to fifty percent of their gross earnings in acting related expenses!
Even actors just establishing themselves are often spending thirty percent or more of their gross income and have little acting income in comparison to show for it. For most IRS employees these are ridiculous amounts they can’t conceive of spending. It is small wonder that when these “Tax Technicians” look at tax returns, especially when they live and work in cities such as Ogden, UT; Holtsville, NY; Bensalem, PA and other hotbeds of the entertainment industry, that performers get called in to explain their activities.
These three locations just happen to be Correspondence offices.
In general there are two forms of an audit; an Office (or personal audit) and a Correspondence audit. Either way you are being audited and won’t get out of it. But to increase your odds of a successful get-together, make sure to deal directly with a well trained and experienced auditor rather than someone even the IRS considers a “Tax Technician” employed at a correspondence office. That usually requires an office audit.
In general the personnel in IRS offices are better trained and, if they are located in larger cities such as Los Angeles and New York, have a great deal more experience in handling returns of performers. This is not the case when you consider the cities I listed above.
Because of their unique expenses, in our office we urge any performer contacted for a Correspondence audit to graciously decline immediately and ask for their right to move to an office audit. You may have to be persistent (but polite) to get your audit transferred. But despite doing everything you do, they may continue to deny you your right. Just remember: It’s your right to do so under IRS rules regardless of what the office may tell you over the phone.
As indicated with the following excerpt from IRS Publication 1 you have the right to request a personal (or office) interview rather than go through the correspondence process. We have bolded the more relevant lines:
We handle many examinations and inquiries by mail. We will send you a letter with either a request for more information or a reason why we believe a change to your return may be needed. You can respond by mail or you can request a personal interview with an examiner. If you mail us the requested information or provide an explanation, we may or may not agree with you, and we will explain the reasons for any changes. Please do not hesitate to write to us about anything you do not understand.
If we notify you that we will conduct your examination through a personal interview, or you request such an interview, you have the right to ask that the examination take place at a reasonable time and place that is convenient for both you and the IRS. If our examiner proposes any changes to your return, he or she will explain the reasons for the changes. If you do not agree with these changes, you can meet with the examiner's supervisor.
In addition Publication 556 states the following:
You may either represent yourself or, with proper written authorization, have someone else represent you in your place. Your representative must be a person allowed to practice before the IRS, such as an attorney, certified public accountant, or enrolled agent. If you are in an interview and ask to consult with such a person, then we must stop and reschedule the interview in most cases.
You can have someone accompany you at an interview. You may make sound recordings of any meetings with our examination, appeal, or collection personnel, provided you tell us in writing 10 days before the meeting.
Obviously you are denied the right for representation when the audit is performed by mail. Again, as we have indicated, don’t be misled; your right for a change of location is IRS law.
If you are a working actor located in Los Angeles, New York (or presumably some other city with a greater experience and understanding of the entertainment world) it makes far more sense that your interview take place with auditors who are locally based and usually far more experienced in the specifics of actors' taxes and the complexities of your particular situation.
The biggest area of problem these Correspondence audits creates is the bureaucratic policy demanding that you submit a letter from your employer validating the reimbursement policy for your expenses. This is caused because IRS rules demand we use a Form 2106 entitled “Employee Business Expenses.” For most businesses this may be a valid request, but not for actors.
Read this part carefully:
For the most part this demand has nothing to do with actors, although the correspondence offices have trouble understanding this. Our expenses are all Job Search activities, including
any payments to your agents or managers--unless
are on a series or under a regular contract.
To quote the Market Segment Specialization Program manual (manuals to guide auditors in various professions) created by the IRS for the Entertainment community:
“The entertainment industry has numerous unions and guilds. Each of these organizations has entered a collective bargaining agreement on behalf of its members. These agreements or contracts address rates of compensation, reimbursements, allowances, hours required to be worked, materials to be provided, etc.”
In other words if you work under a union contract you are always reimbursed under our contracts for any expenses you may incur as a result of the work. What you are writing off is the costs of the process to prepare you (education) for work and to seek work. Even compensation to your agent is payment for them seeking work for you. You aren’t paying them because you worked but because they worked to find you the job in the first place.
We suggest you attend the Audit
Although you have every right to have someone represent you at your examination, we urge you to attend the meeting regardless. Many tax professionals believe that the tax payer should stay away from the examination. We disagree. Unless your preparer is a performer themselves chances are they will have no idea what most of your receipts are for and if you aren’t there to explain, you will probably lose the deduction.
The audit process is to allow the auditor to go through your receipts and records to validate what you wrote off. No one else knows what you did throughout the year and there is no way anyone else can be as familiar with, and be able to explain, your expenses as you are.
Years ago a CPA acquaintance of mine once said that he enjoyed going to audits for his clients. As he expressed it, “I like giving away someone else’s money.” What he meant was, typical in the mind of most accountants, if they can get you out of an audit for the least amount of their time and your money, that’s a win. Though it may sound right, we don't think it is.
We believe if you have been trained to understand what can be legitimately written off in the first place and can bring the proper records into an audit to validate those expenses, there should never be a reason for you to be concerned about losing money in an audit, let alone watching the clock concerned about your accountant's time during the examination.
There is a lot more information we can offer you about audits, in fact too much to try to place here. If you have more questions, particularly about a correspondence audit (audit by mail), please do not hesitate to call us.