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Tax Audit Entertainment Industry

They’ve just done it again! The IRS has targeted the entertainment industry for tax audits. If you’re an actor, director, producer, entertainer, composer, writer, film star, rock star, producer, recording artist, musician, publisher, manager or in any other way related to the music entertainment, film or related industry, you can or probably should suspect that you will be a target for the IRS examination of your tax returns.


This October, the IRS has released its Entertainment Audit Technique Guide as guidance to assist IRS auditors in the audit of individuals and businesses involved the entertainment industry.  The audit technique guides were developed as part of a Market Segment Specialization Program to target certain industries in which the IRS will generally apply additional scrutiny or consideration in enforcing compliance with tax reporting.


On the income side, the IRS will review residuals, royalties, licensing fees, fringe benefits, advances and more to ensure that all applicable revenues are fully reported. On the expense side, the IRS will scrutinize your record keeping, reporting compliance, the failure to capitalize, depreciate and amortize expenses, employment taxes, home office deductions and more to ensure that deductions actually exist, are not “personal” in nature and are fully supported in accordance with the strict reporting requirements of travel, meals and entertainment deductions required by law.


Remember that an audit of this year’s targeted tax industries may not hit you until around two years from now unless your returns are specifically targeted for other reasons. That does not mean you have nothing to worry about for two years. What that means is that THIS year’s return may not be audited for another two years, but by that time its highly likely that your audit will include this year’s returns, next year’s returns and possibly the year after that — all at one time and all with the same audit issues. So the time to get your affairs in order is NOW so you don’t get killed on your tax audit later.


Many of the tax strategies previously overlooked are being specifically targeted as “suspect” from the write-off of entertainment expenses, equipment leasing contracts, reimbursements, fringe benefits, income characterization, home office deductions and more. On the up side, we can make certain affirmative elections to allow you to take expenses, or a portion thereof, currently, rather than capitalize and amortize up front costs over a much longer period of time that would otherwise be required by law.


Whatever the case may be, the key in successful tax negotiations lies in the planning – the early identification of tax issues, strategies and the implementation of those strategies early in the game to help achieve the most optimal success.




IRS Red Flags 2013 – 18 Red Flags You Need to Know

Have you ever known someone who had an income tax audit by the IRS or state taxing authority? They’ll tell you that once was enough and in most all cases, will do everything not to have that sort of problem ever again. It’s important to know how an audit is triggered and what you can do to prevent one from happening to you. Here are some of the more common audit red flags you should know. Continue reading

What To Do In An IRS Audit

Knowing exactly what to do if you get audited will depend on the nature of the audit examination. Correspondence audits are handled much differently that field examinations or office visits.
Correspondence Audits
Most IRS audits are correspondence audits where you’ll receive a letter explaining what problems may exist and the IRS determination of what the corrections will be and the taxes you may owe.  You may be able to simply read the letter and determine if you agree with the proposed changes.
  • If you agree with the proposed changes, simply sign and date the proposed changes and include your check for any amounts owed.
  • If you don’t agree with the proposed changes, you may simply reply that you don’t agree and provide information in support of your position. However if the issues are complex, you’re almost always better off to request a face-to-face meeting with an IRS examiner.
Field Examinations and Office Visits
Other audits require an office visit (where you are instructed to call to schedule an appointment with the IRS to discuss your return) or a field examination (where the IRS will visit you) to review your tax return(s).  Recommended steps are to:
  • Consider hiring a tax professional to represent your interests;
  • Call to delay the audit to allow you additional time to gather your records;
  • Refigure your tax return by comparing the information reported to your records;
  • Look for other deductions you may have missed;
  • Research any tax or legal issues that you were unsure of, or were questionable;
  • Assess your tax risk on each of these issues
Often many taxpayers incorrectly believe that if they’re good, honest, people, they can somehow befriend the tax examiner and everything will be all right.  This is just simply not true.
The IRS tax examiner is simply doing his job. His job is to protect the government’s interests and collect additional taxes from you that you may owe. Tax examiners are skilled and experience in their techniques and will strive to collect information that can be used against you.

Hiring a IRS Tax Professional

You have certain taxpayer rights to protect your interests.  Most importantly, you have the right to professional representation. Hiring a professional is no admission of guilt – its simply a sound business practice. Most seasoned IRS examiners would prefer to deal with a licensed professional anyway – one that understands your reporting obligations and will not get emotional when errors are found.
The IRS tax examiner is simply doing his job. His job is to protect the government’s interests and collect additional taxes from you that you may owe. Tax examiners are skilled and experience in their techniques and will strive to collect information that can be used against you.

IRS Audits On the Rise For International and High Net Worth Taxpayers

The enforcement of tax laws is a chief component of IRS effort to enhance voluntary compliance. Recently, the IRS Commissioner outlined IRS intentions to focus on tax evasion as it relates to international taxes in the forthcoming year with an increased emphasis on high-net worth taxpayers [IR-2010-122, December 9, 2010].

In 2009, IRS examinations were directed to international taxpayers, high-net worth individuals and non-filers.  Overall, IRS examinations have increased by approximately 3% over the prior year and are expected to increase consistently hereafter.  Of particular significance are audits of high-wealth individuals, which have increased 11.2%. Large corporation audits have also increased by approximately 3%.

If you maintain assets off shore, the IRS has not only put increased pressure on disclosure by foreign banks, but has put in place initiatives to form cooperative, joint agreements with foreign countries to share information and raise tax revenues.

With regards to corporations, new legislation includes the Foreign Account Tax Compliance Act (FATCA).  FATCA provides the IRS with better transparency and additional tools that we need to crack down on Americans hiding assets overseas. FATCA will increase information reporting by U.S. taxpayers holding financial assets outside the United States and impose stiff penalties for failure to comply. It will also require reporting of U.S. persons who hold accounts in foreign financial institutions or who own large interests in foreign entities that hold such accounts.

The IRS has placed a series of extremely harsh penalties on taxpayers who fail to report foreign holdings and transactions.  Taxpayers who continue to not file a required return and fail to respond to IRS requests for a return may be considered for a variety of enforcement actions. Continued non-compliance by flagrant or repeat non-filers could result in additional penalties and/or criminal prosecution. Voluntary disclosure of offshore accounts may be a taxpayer’s best defense for mitigating damages that may arise.

New IRS Employer Examinations

The Internal Revenue Service (IRS) has recently begun a 3-year National Research Program to randomly select and intensely audit approximately 6,000 companies to focus on employment tax issues to include review of independent contractor status, executive compensation, fringe benefits and other employment tax issues.  This is a first attempt (in approximately 25 years) where the IRS National Research Program has targeted employment tax. The goal of the IRS is to identify areas of noncompliance across industry sizes and sectors including nonprofits and governmental entities, with an ultimate goal of revenue collection.
The employment tax examination issues will include independent contractor/worker classification issues, including executives rehired as consultants, dual status employees and employee leasing arrangements.
Fringe benefits reimbursements examination for “personal use” including not only income tax but backup withholding of an additional 28% (including cell phone use, credit cards and other non-cash benefits).  Executive compensation and fringe benefits include use of company cars, planes, executive retirement contracts, golden parachutes, stock options, etc.

Independent Contractor v. Employee

Perhaps the most common area of concern of small businesses is the classification of workers as independent contractors (not employees). This classification generally results in a decreased economic burden of the business to avoid payroll taxes and other economic costs associated with employees.
The determination of employment status is generally based on 20 factor common law test (not statutorily defined).  Be advised that the IRS will almost always reclassify all workers as employees. These factors are designed to determine the degree of “control” of the paying entity and the elements of “economic risks” of the payee. Factors to be included in analysis by employers include:
  1. Compliance with instructions
  2. Training provided
  3. Integration with business activities
  4. Personal rendition of service
  5. Hiring, supervising and payment of assistants
  6. Existence of a continuing relationship
  7. Set hours of work
  8. Exclusivity
  9. Working on the employer’s premises
  10. Sequence of work done
  11. Reports recruited
  12. Payment by hour, week or month (not as a percentage of collections)
  13. Expense accounts
  14. Tools and materials supplied
  15. Facilities furnished
  16. Risk of loss to worker
  17. Number of “employers”
  18. Availability to general public
  19. Power to fire
  20. Termination damages
Generally, the greater the control of the payer; the greater the risk that it will be determined to be an employer. The use of a worker agreement in which the person acknowledges being an independent worker is irrelevant.

Safe Harbors or Exceptions

Fortunately, certain safe harbors are available (IRS Sec. 530).  The main classifications of this exception include:
  1. Judicial precedents, published IRS rulings, technical advice memorandum or private letter ruling or determination ruling
  2. A log standing recognized practice of a significant segment of the industry in which the taxpayer is engaged (Industry segment should be 25% or more);
  3. Statute allows the taxpayer to demonstrate “reasonable basis” for its treatment of workers is some other manner
However, even if you satisfy one of the requirements of IRC Sec. 530 you must meet other requirements:
  1. Taxpayer must not have previously treated the individuals as employees;
  2. Taxpayer must have all required informational returns;
  3. Consistency requirement in how payees are treated
The burden of proof is on the IRS once the TP establishes a prima facie case (meet factors of IRC Sec. 530 and other requirements).

Consequences of a Payroll Examination

There are unfortunately various consequences to taxpayers that may be asserted by the IRS.
  1. The Company may be subject to backup withholding – current rate of 28%;
  2. There may be a disallowance of income tax deductions not paid pursuant to an accountable plan;
  3. There may be additional income taxes imposed upon recipients of employee benefits that are deemed to be wages or taxable income;
  4. There may be asserted negligence penalties of 20% on additional tax obligations;
  5. There may be asserted penalties for failure to provide Forms 1099 or W-2

What to Do

If selected for a payroll tax examination don’t panic — just get professional help.  Review your current employment arrangements with your advisor and determine your degree of exposure, if any.  Review the 20 factor test, see to what extent the safe harbor provisions apply and gather the necessary documentation in support of your positions.  In summary, be prepared, hire professional advisors and take the necessary steps to reduce your exposure that you haven’t already.