If you are working in the entertainment industry, the IRS has your tax returns in its sights.
In a new “Entertainment Audit Technique Guide,” the IRS recently instructed its auditors to closely examine tax returns from those in the entertainment business. Auditors will be scrutinizing deductions claimed on tax returns for expenses which, according to the guide, entertainers have historically been “aggressive or abusive” in taking.
The IRS wants to reign in these perceived industry norms to ensure that the entertainers are legitimately entitled to the claimed deductions. In tax parlance, the expenses giving rise to deductions must be “ordinary and necessary.” As the guide puts it, “The distinction between ordinary/necessary and extravagant must be more clearly drawn.”
Those in the entertainment business can include, but are not limited to, comedians, musicians, singers, songwriters, actors, producers and those involved behind the scenes. The IRS wants to see that the deductions entertainers are taking are substantiated with legitimate receipts and records, and that the expenses truly are business-related (i.e. “necessary”).
Though the guide focuses on expenses and deductions, it also educates IRS auditors on the different types of income generated in the entertainment industry, including from copyright sales and royalties, as well as residuals in the case of the film industry. The guide instructs the auditor to ensure that the income has been classified and characterized appropriately. Depending on how the income was earned or generated, it can be non-passive, income from wages, self-employment income, etc. A certain type of income’s classification can make a huge difference on how it is taxed and what types of deductions may offset it.
The guide also addresses the taxation of perks. In addition to pure monetary compensation, for instance, performers may receive free wardrobe from a movie’s producers, or they may receive free products as part of shooting commercials for the products. The guide reminds IRS auditors that these perks may not show up on the entertainer’s tax return, but they are nevertheless taxable as goods received for services performed.
The bottom line is that the Entertainment Audit Technique Guide is more than 100 pages long, indicating that the IRS considers tax compliance in the entertainment industry as serious and a high priority.
We encourage entertainers to hire competent professionals to manage their tax compliance obligations and business affairs. Protect yourself on the front end, because the time, energy, and expense it takes to survive an IRS audit will have you singing the blues.