How to Survive an I.R.S. Audit

Jalapeno Brothers founder Glen Schweitzer endured the rigors of an IRS audit and has decided to help other musicians by spelling out what happens and how you can get through it. Read this one folks, whether you like it or not.

I must preface this piece by stating that I personally do not endorse or suggest any illegal or fraudulent misrepresentation of one's self or one's income, to the U.S. Treasury or anywhere else in life for that matter. I make no claims of being a tax professional, I do not admit to having used any of the following techniques, as a means of "beating the system." My objective is mainly to offer you my perspective and relate information to you that may assist you in keeping a fair portion of your earnings. I strongly believe that you are entitled to what you earn. The information that I am about to share with you may assist you in doing so. I also believe that contribution of tax dollars is essential in subsidizing everything from, programs that are earmarked to support the arts, to maintenance of a society's infrastructure. After all, somebody's got to pay for repairs on our road ways. Tax dollars create jobs, educate our children, ensure National security and provide for many of the resources that we simply take for granted.

Having thought about this topic long and hard, and even more poignantly stated, having recently endured the rigors of an audit of my band's 1995 tax return, as a service to my peers, and having learned the hard way, I felt the need to turn you on to some tips that will assist you through the process, should you get audited. It's also my intention to offer some ideas that will enlighten you as to how the system works and some ways to avoid drawing attention to yourself and your band.

Until very recently, consensus has been that the Internal Revenue Service, a branch of the U.S. Treasury, is an independent entity, accountable to no one, not even to the general accounting office. It has also been understood in the past that they have exceeded reasonable authority and, following congressional hearings, it was determined that not only had they overstepped their bounds, but resulted to extortion and countless unethical, unscrupulous acts in some cases. These reviews resulted in an "overhaul" of the IRS that was prompted by public outrage. Public relations efforts have been notably attempted to soften our image of this branch of government. There has typically been a prevailing sense of fear and intimidation when one considers the ramifications of an audit. Unless you report every dollar that you earn (like I do) there is a possibility that you will be audited. For the most part, if you tell the truth, you probably have nothing to worry about. Isn't it funny how that relates to most areas of one's life? The following will hopefully give you some insight and inform you of your rights involving the audit process and relating to your taxes in general.

How to document expenses:

Within your master calendar/date book, there should be a space listing each scheduled show, itemizing gross pay, amount and method of payment, players used. There should also be a section that documents expenses, food, soundperson and agent's commission relevant to travel to and from each show (particularly if you're on tour). Each employee's gross pay should be clearly listed. In addition, you should also maintain an annual ledger book that breaks these issues down into great detail. Your ledger book serves two purposes: first, it acts as a second "hard copy" of your financial records. It will corroborate information logged in your calendar, should you ever be audited. When paying an employee, band member or band related bill with a check issued from a band bank account, it will also serve as another form of documentation and allow you to triple check your figures for accuracy come tax time. Then of course, there is the obvious: Once, while playing in Pittsburgh, our band's truck got broken into. Two items were stolen, a leaky Styrofoam cooler full of warm bud cans, and my date book. If not for my trusty back-up left at home, I would have no way of knowing what we had been paid that year and where we were booked to play from that point on. As I said, the most important reason for having a detailed duplicate is to corroborate all of your figures, posted on check book stubs and elsewhere.

Purchasing a blank (unused) calendar, at the beginning of each year is also a good idea. It will allow you certain options at a later date, should you need to justify income versus expenses. You figure it out.

What are your rights, should you be audited: 

Of course you may represent yourself. You know that old adage "A person who represents himself has a fool for a client." Not always true in this case. I represented myself and won. You have the right to be represented by an accountant or tax attorney. You may also send a representative in your place. You must complete form number 2848, authorizing power of attorney to another individual. Use a professional whenever possible. It is more likely that they are up on changes in tax codes and laws. You can request these and other forms I mention by calling 1-800-829-3676. They will also provide you with a more comprehensive booklet that outlines your rights.

The audit:

The audit process is usually held in a "conference type" room and are fairly informal in nature. An uptight, defensive posture can work against you. Keep in mind the auditor can take certain liberties in allowing or disallowing any of your presented materials. Above all, it is in your best interest that either you or your representatives be well versed in the organization of your receipts, previous year's returns filed, etc. The main thing is to be organized. The auditor is usually only interested in few particular areas. If they make sense to him/her, chances are that they will assume that all of your paperwork is in order. However; there are exceptions to the rule. In my case, I had a relatively cool person who was auditing my books. Although she was cool and we had a good vibe from the onset, she added every last receipt and triple checked balances for accuracy. Having been well prepared, the entire audit only took about six hours. On the other hand, if I had handed her a milk crate full of disorganized receipts, it could have taken days. It is also likely that I would have wound up offering less than my most accurate accountable details. Save every receipt and have them neatly categorized with totals relating to each expense category.

Why me?

Each year the IRS randomly selects a percentage of the population for audit. Your income to expense ratio may also throw up a red flag. I'll get to that in a minute. Generously speaking, musicians fall into a low tax bracket and are seldom audited, simply because, compared to others earning large sum of money there is less incentive and collection potential in dealing with musicians. Typically, auditors have worked on a quota system, and are offered incentives to pursue those who may yield the greatest collection potential. They are also fully aware that a good portion of our earnings are paid in cash (largely unaccountable) and hard to trace. What may attract their attention is what they may perceive as an unreasonable amount of expenses versus reported income. For example: if you have reported that your band has earned $85,000.00 and have itemized $140,000.00 in expenses or losses. You need to be realistic. Also, keep in mind, as a general rule of thumb, if you report a loss for three or more consecutive years, they may classify your vocation as a hobby and disallow your itemized deductions. You should show a profit once every three years, hopefully more often than that. Another possible scenario - A disgruntled, ex-band member can report you, citing fraudulent or negligent bookkeeping. Although unlikely, I have heard stories of ex-band members prompting audits. There are methods of legal retribution, should this be the case. In case you were wondering, my audit was prompted by a disproportionate income to expense ratio. 1995 was a losing year aside from a huge boost in popularity and jump in CD sales, which made for an exceptional year. Quite honestly, we took a financial beating.

To determine your methods of bookkeeping and continuity, from year to year, they may ask to see returns filed from the year before and the year after the one being examined. As I said, to look at it on paper, 1995 was a terrible year. We reported massive expenses which seemed unreasonable and disproportionate as compared to subsequent returns. I was able to justify expenses by having supporting documentation. Due to a lot of travel, domestic and international (we toured extensively that year to support our new album Growing) there were also manufacturing and promotional costs incurred to support the new release. We also put up a web site and did frequent mailings. So showing a loss every couple of years is not unexpected or unreasonable. There have been years where we had incurred a loss but reported a surplus or gain. You may ask, why the hell...? There are two reasons: As I've said, if you show a loss for more than three consecutive years, the IRS can classify your business as a hobby and disallow itemized expenses which are meant to offset income. Also, the obvious: If you will ever want to qualify for credit, get a bank loan for a new band truck, etc., you will need to be able to document a winning history.

Issuing a 1099 and who should get one: 

You will want and need to fill out a 1099 form for all of your band members and subcontractors. Basically, this applies to anyone who provided service to your organization. Few bands (relatively small operations) incorporate or use a Federal Tax ID number. Usually what winds up happening is, the band leader assumes responsibility and forks over his/her social security number. Those who have paid you, club owners, promoter, agents, etc. will probably 1099 you as well. Remember, you are an expense or write-off to them as well. If you are a leader of a four piece band, and the band grosses $80,000, you will not want to have to assume full tax liability for the whole amount. You should be paying income tax on one quarter of this or $20,000. The expenses that I have mentioned which you have documented will offset this amount. Your band members, who you will give 1099's to, will assume responsibility for the remaining $60,000. At your discretion, you are not required to 1099 anyone who earned less than $600 that year. For instance, your drummer couldn't make a particular show and you hired a sub. You paid the sub $150.00 . Although this can be itemized as an expense, it's probably not necessary to 1099 this individual. If you did it would probably annoy the piss out of them and it's petty (in my opinion). By law, you must sent the 1099s to all of your subcontractors by February 1, relating to the previous year. The form is filled out in multiple parts, meaning a carbon copy goes to them for filing of their individual taxes; one stays within your files and one copy gets submitted with your tax return. Your tax preparer or accountant can do this for you or show you what to do.

What do I do if I get audited?

Customarily, you will be notified in writing. They will specifically let you know what they are interested in examining. They will want receipts, canceled checks, check stubs and all of the documentation I have mentioned to substantiate your deductions. They will assign you an auditor and date to report. You may defer your appointment to allow for additional time to organize and prepare. If a date has not been pre-scheduled they will require that you call within ten days of notification to find a mutually agreeable date and time. An alternate location is an option if you live in an out of the way place. You may also respond by mail, however, I believe it is in your best interest to be represented in person. Obviously, you would have a better chance of explaining unanswered questions or justify something that may be unclear to the auditor. If something comes up and you are unable to make your appointment you are permitted to reschedule twice. It's in your best interest to give them as much advance notice as possible if you won't be able to make it. Concluding the audit, you will have a general sense of how you made out. The auditor will take photocopies of some documents, review notes they've made about your presentation and may do some investigative work to verify some of your claims. Within a few weeks you should receive their determination in writing.

What happens after they've made their determination?

If you did a good job, there may be a change in your tax liability and they may owe you a refund. This is uncommon but does happen. There is a criteria that relates to a statute of limitations regarding timeliness of refund and requests. You'll need to inquire if you've been fortunate enough to have won a refund. It is also possible that you have won, and there is no change is amount owed. It's a hollow victory but at least you don't owe additional money. If you lose, you are entitled to an appeal. If you disagree with their findings, you may begin the process by sending a letter of intent to the Internal Revenue Appeals Office. Request pamphlet number five, which clearly outlines your rights. You may also take your appeal to the US Tax Court, US Federal Claims or the US District Court. If the decision has been overturned you have the right to request the recoup of certain administrative costs associated with your defense. Keep in mind, you are re-opening an investigation and may inadvertently be opening a whole new can of worms. It is possible that, in re-evaluating your audit and records you owe even more than first determined. In my opinion, if you lose on your initial audit, and they determine that you owe an additional $300, you may be better off cutting your losses and just paying that amount. If you lose your appeal, it is possible that they predetermined the amount that you owe and it could be a much higher amount.

If I lose, can I work out a payment plan?

The answer is usually yes. They are pretty cool about this and will allow you an opportunity to repay the amount in reasonable payments and in a reasonable amount of time. If you miss a payment for any reason, there are usually penalties involved and they also have the prerogative to cancel the agreement at any time. If you refuse to pay, they can sieze your bank accounts, garnish your wages and levy liens against personal property. It's brutal and I've seen it done.

In conclusion, I hope that this will assist you in preparing a safe and accurate tax return. Best wishes and happy returns.

Resource guide:

Contacts, departments and phone numbers...

Problem resolution office: (800) 829-4059

They are there to help with unresolved tax problems, hardships cases, etc.

General tax info: (800)-829-1040

Forms and publications: (800)-829-3676

IRS fax forms (703) 487-4160

You can fax them your request for forms and they'll reply by fax.

Internet contact: http:://www.irs. ustreas.gov 

Glen Schweitzer is the founder and leader of Vermont's long-running rock band The Jalapeno Brothers. The last Jalapeno Brothers CD was called Growing and their next will be called The Fat Lady Has Sung. Glen also plays guitar in the newly re-vamped band Blues For Breakfast.