How to Survive (and prevent) Audit Hell

Dear Fellow Artists,

     I am taking a detour from my normal blog subject matter, because I want to share with you my recent experience of being audited by the IRS. I hope that you will benefit from hearing about my experience, and that it will help you better prepare your taxes so that if you are ever audited, the process will go smoothly.

The first piece of advice I have for artists and individual contractors is:

Do NOT do your own taxes. I repeat, do NOT do your own taxes.

I know that none of us want to spend the money on an accountant when we can just use Tax Cut or Turbo Tax, but no matter how much research you do, you can’t possibly know as much about tax code as a certified accountant who specializes in artists’ taxes. You WILL make mistakes, and you will be held accountable for them if you are audited, even if your mistakes were made out of genuine ignorance. Another reason to have an accountant do your taxes for you, is that if you are a freelancer AND you do your own taxes, you are automatically placed in a group of people who are more likely to be audited. I know it is unfair, but now you know.

In case you are audited, here is what will happen. You will get a letter from the IRS telling you to call and set up a meeting to discuss specific parts of one or more years of your taxes. You will go through your piles of paperwork for that year and try to make sense of everything before you go to the meeting. At the first meeting, which will last several hours, the first thing the auditor will do, is take your bank statements and add up all of the deposits. If your deposits exceed your declared income, you have a problem. You will then need to explain every deposit that exceeds your income. You will rack your brain trying to remember things from years ago. You will have to call your banks, credit card companies, cellular service provider, utility companies, and anyone to whom you paid money to get statements and receipts. You will have to prove that each receipt was indeed for a business expense. You will be asked to show multiple forms of proof for your deductions. You will be asked to present a log of your business travel, events, expenditures, etc. You will jump through hoop after hoop. You will sweat, you will lose sleep, you will feel sick, and if you are like me, you might even cry over it because it is so stressful. You will feel like a spotlight is shining on your lousy spending habits and pithy income. You will feel victimized, judged, and misunderstood, and then you will get angry. The IRS will treat you as if you are guilty unless you can show multiple forms of proof that you are innocent. Hopefully you will be smart enough to get the help of an accountant who specializes in working with artists. At which point she will point out all of your mistakes and help you resolve them. She will explain the twisted logic of the IRS and go to bat for you with the auditor. She will tell you exactly what you need to do to make it all ok, and she will handle meetings and paperwork from that point forward. If you are lucky, she might even give you a hug and tell you that no, you are not a bad person, and yes, you really are relatively organized for an artist.

This is what I have been going through over the past 5 months, and I sincerely hope you don’t ever have to go through it. But if you follow my advice, then you can rest assured that even if you are ever audited, you will be in the clear.

1)   Use an accountant who comes highly recommended and who specializes in your field.

2)   Get paper statements mailed to you for every account you have, including cell phone bills, utility bills, savings accounts, brokerage accounts, IRA accounts, and credit cards. Create a folder for each account, and group accounts by year. As tempting as it is to do everything on line, you need these paper statements and the images of your checks that have cleared. Yes, this is a ridiculous waste of paper and space, but the IRS loves paper waste. If you don’t save these paper statements and you are audited, you will end up having to pay a lot of money in fees to re-order them.

3)   Save all of your receipts in large manila folders. At tax time, go through all of your receipts, and determine which receipts can be used for deductions, and how to categorize them. (More on categorizing below)

4)   Buy checkbooks that have carbons, and use those carbons as receipts. (For example, when you write a check to a coach, you can then use the carbon copy as a receipt for your records). You will also need copies of your canceled checks if you are audited, but carbons are great for your own personal use, to help you remember and categorize your expenditures.

5)   Keep a log, electronically or on paper. This should be some kind of calendar where you will indicate all of your expenses and business related appointments. (For example, May 4 dance class $15 cash, May 17 voice lesson $120 check, June 12 Flight to L.A. $345 visa). I use the calendar function in Yahoo, and I found that it works well and saves your entries from many years past.

6)   At the end of the year, go through your bank statements and add up your deposits. Compare the amount to your W2 and 1099 declared income. You will need to justify any discrepancies. Here are some examples of why there may be a discrepancy: Did you babysit / teach / sing in church / get cash gifts / tips / scholarships / grants, etc? Did you receive money from subletters that you then had to turn around and pay for your rent? Did you get a big tax refund the previous year? Did your family give you any money? If you are audited, you will need proof of any of the above, and if it falls into the “taxable income” category, you will have to pay taxes on it. If you are freelancer, the first thing an auditor will do is compare your deposits to your declared income, and try to nail you for not reporting the money you receive. Be ready.

7)   Know that if you declare a loss on your business AND you deduct a home office, you are much more likely to be audited.

8)   If you have a home office, be sure to be able to prove the square footage of the office space. Take some pictures so you'll have them on your computer if necessary. Also – remember to declare a home office only for the months that you were in town. The IRS loves to try and nail people who have a home office, so be sure to only use this deduction if you need to. 

9)   Try to pay for things by check as much as possible so that you will have the carbon and the canceled check as receipts, and always get a receipt if you can’t pay by check.

10)  If possible, use one or two separate credit cards for business expenses only. As mentioned above, keep your paper statements organized and ready. 

11)  When you are shopping, if you are buying things that could fall into two or more different deduction categories, pay for them separately so you will have separate receipts to categorize later.

12)  For all of your deductions, write on the receipt exactly what the expense is for. For example, if you get your hair done, be sure to write what gig or photo shoot you have coming up on the receipt. If you eat out with a colleague, write down their name and what business you discussed. If you buy clothing, specify “audition dress” or “concert dress”, etc. This will save you a great deal of time later.

13) If you sublet your apartment, you must keep your sublease contracts to prove that the money you received from them was not income.  Photocopy the checks they give you before you deposit them, so you can prove that the deposits reflected on your bank statements are indeed from a subletter. If you are subletting for more than you pay in rent, you must declare that extra amount as income, or prove that it was used in preparing the apartment for the subletter (cleaning supplies, etc.)

Categorize your Deductions, and have receipts for everything:

Union Dues

Agent Fees

Professional Training (lessons, coachings, etc.)

Publicity Materials, Advertising

Office supplies / Business Equipment (including postage, reprinting,          stationery, computer, piano tuning, etc.)

Sheet Music / Recordings / Study books

Trade Publications (Classical singer, Musical America, Yaptracker, etc.)

Stage Makeup / Hair

Language Training & Materials

Professional clothing

Business Gifts (backstage tips, cast gifts, etc. You may only deduct $25 per person for business gifts)

Business Meals (You may only deduct 50% of your meal)

All business travel expenses, including luggage, mileage, gasoline, train/plane/bus tickets, car rental, hotels, travel supplies, cabs, etc.

Travel Perdiem: The IRS web site will tell you the “perdiem for each city. **You are only allowed to deduct half of the perdiem. You may also deduct $3 for “tips and laundry” every day that you are on a business trip.

Home Office: Be very careful with this. Do not declare over 25% of your home as your office, and you must be able to prove it. This includes 25% of your rent and utilities. You will need a copy of your lease to prove your rent cost, as well as all of your utility bills. I suggest taking a more modest approach, like 15-20%. 

Business phone (if you only use a cell phone, you can deduct half. If you have a home phone, you can declare 75% of your cell)

Professional Viewing (theater / concert / opera tickets / films related to your field)

Tax preparation fees for previous year

Medical Expenses, including insurance premiums and prescriptions

Charitable Donations

Estimated Taxes Paid

Be sure to save and include all statements you receive for interest and dividends received, unemployment received, sale of stocks / mutual funds, IRA distributions, student loans, and Mortgage and Co-Op information.

I know how overwhelming all of this can be, but it is much easier if done in advance of an audit. You will sleep much easier knowing that your taxes are done correctly, and that you are prepared. I sincerely hope that you are never audited, but it is happening more often to people in our business. I hope this will help you prepare, but even with all of this information, please resist the temptation to do your own taxes. If you are audited, (and you are statistically more likely to be audited if you do your own taxes) you will deeply regret it. Seek out the services of a professional who specializes in working with artists’ taxes. Choose someone who has a good bedside manner, so that your auditor will be more likely to negotiate with her and respect her. This will be money well spent. Given the financial stress that we as freelancers all continually face, it is worth it to have our taxes not be an additional source of anxiety. 

Best wishes to you all!!!

Alison Trainer