writers.com feature:

The Audit: A Real-Life Tax Adventure

(Originally Published: April 15, 2005)

By Paula Guran

In other circumstances the auditor might have been the federal equivalent of Hannibal Lecter and served my financial liver up with fava beans and a nice Chianti, but for the average taxpayer he was exactly what you hope your tax dollars are being spent on...

As something of a horror maven, I'm used to dealing with scary subjects. I don't get chills when I read about ghosts and I don't shiver in terror at the thought of supernatural monsters. But, in the United States at least, there are a few things that make us all shudder, things like the words "Internal Revenue Service" and "audit."

I just survived my first tax audit. Since tax season is upon us, I thought sharing my experience as a writer/ editor/ teacher/ agent/ webmaster/ publisher in this situation might be of interest. We also have a related article, The Taxman (or -woman) Cometh that provides some tax advice resources for writers.

An audit, at least on the auditee's side, starts when an ominously official-looking envelope lands in your mailbox. In my case it was threateningly thick and identified specific items on my return for 2003 that were in question. The letter set a date and time and "requested" that I (or my representative) bring certain documents to my local IRS office for an auditor to examine.

I do my own taxes, so it was not a matter of calling my accountant or tax advisor. It was all up to me.

Like many freelancers, I file a Schedule C of Form 1040, "Net Profit from Business -- Sole Proprietorship." Two of the questioned areas -- charitable contributions and mortgage interest -- were on my Schedule A of itemized deductions and had nothing to do with my business a writer, etc. They were also probably the easiest to substantiate. You either have the legal documents and receipts or you don't. I had the proper paper and, except for digging through a lot of cancelled checks and a few files, this part was relatively easy

But, let's start with a CPA who evidently *does* know his stuff:

LESSON ONE: Documentation and receipts. Have them. If you do, you will probably have no major problems. I didn't. This may be obvious, but we sometimes ignore the obvious.

The other queried areas concerned the two Schedule Cs I filed one as a publisher and the other for what I term "literary services" (all those things I do to earn money that are all, more or less, related to writing and authors and such.) For the year being audited, I had reported a loss for these businesses.

One Schedule C was for a newly established business that had had no gross profits, only expenses. Pretty much everything was in question. They wanted me to show my profits and asked for all (both personal and private) bank accounts, deposit slips, investments, ledgers and journals, plus purchases of property, etc. The inference was clear: Where are your profits? Are you hiding them?

This inquiry gave me a few palpitations. Any reasonable person would immediately understand the situation: new business, no sales yet. But this was the IRS. Would they be reasonable? If I had no gross profits, how could I show I never had them and prove they went nowhere? Were we dealing with the nature of reality here?

I prepared anyway, as best I could. I got bank statements and my checkbook ledger. I had no deposit slips and there were other items I was missing. I had no car, boat, or property purchases to be concerned about. Still, I spent many resentful hours compiling and organizing and wondering why the heck they weren't out rounding up the real bad guys cheating us all out of millions.

LESSON TWO: As your official letter says, an audit is not an accusation of dishonesty. You probably can't help feeling that it is, though. I guess the best idea is to use the energy you are feeling to fuel your efforts to pull all your evidence together. I can't say I managed to do this.

In my audit, rationality reigned. Reality as I knew it was noted and we moved on.

The rest of the audit involved the areas that concern most writers: business and travel expenses. I went back over all my receipts, checkbook entries, and credit card bills -- just as I had done to come up with the figures to begin with.

LESSON THREE: This would have been a lot easier if I had kept all the "scratch sheets" I had used to tote things up. I had to, in some cases, go through all my receipts, check book entries, and credit card bills to see why I had taken $X off for something. It might have been easier still if I had kept track of things during the courses of the year -- preferably with accounting software -- than just sorting it out at year's end.

However, I made some interesting discoveries with my archeology and reconstruction. I had "missed" things. I forgot to include documented long distance expenses in my telephone costs. I had not taken even the standard meal deduction for my trips. (Even if you don't keep receipts, the federal government assumes you eat.) I discovered the fuel and toll receipts from transportation by automobile to a convention. I made other discoveries. I went ahead and added all the information up, made sure I had the back-up info, and kicked myself for overlooking these things.

LESSON FOUR: I have no idea how I missed these items or mistook the figures. They were all right there in my records. I had been in no great rush to do my taxes that year, so that was no excuse. I've definitely resolved to go over everything next year with a much finer-toothed comb.

I also found some obvious expenditures for office supplies and downloaded software charged to my American Express card that I had no receipts for and had made no notes concerning. At this point I could not recall what they were for. I'm pretty sure they were business-related, but there was nothing to prove this, even to myself. I did not include them

LESSON FIVE: Receipts, receipts, receipts...including email receipts for downloaded purchases.

To be deductible, a business expense must be "ordinary and necessary." What is "ordinary and necessary" for a writer may not be apparent to either the average person or the average tax auditor. I took the time to look at my expenditures from that viewpoint. In a couple of areas, I even made notes to remind myself of what went into a total and how it applied to my work. This paid off in two ways: I felt more confident that I was well prepared and I had the information, if needed, for the audit.

LESSON SIX: It doesn't hurt to organize your thoughts and attitude as well as your paperwork. (Remember, you need only to focus on the areas questioned. Don't waste time elsewhere. If the IRS does not ask, then you do not need to answer.)

I had my pertinent materials and felt I had done everything I could to prove my figures and explain my positions. I was armed with receipts and righteousness and had worked out the rage. I had no angel with a flaming sword of truth at my side, but I did have a briefcase bulging with color-coded folders full of relevant papers.

Did that mean I slept peacefully the night before the audit? Of course not. I was still worried. Death and taxes: the inevitable, the ultimate, the mysterious, the inescapable... Okay, no death, but taxes are enough.

The day of the audit I gave myself plenty of time to find parking and arrive as scheduled. I didn't need the extra edginess of having to rush. Even with what I thought was "plenty of time," I still wound up with "barely enough time." I had forgotten how tight security was at a federal building. My purse and its usual nonlethal contents have passed through about two dozen airport security checks since September 11, 2001, but not THIS time. We eventually determined the culprit to be a tube of lip-gloss. This took up the extra ten-to-fifteen minutes I thought I had allowed.

LESSON SEVEN: Know where you are going, where to park, what to expect on the way to your appointment.

My auditor turned out to be a human being. Yes, I know that may be hard to believe, but it is true. I suspect that most IRS auditors are human beings. I also know there could have been nothing he could have done if I had, flat out, not had reasonable proof of what I had claimed, nor would he have been as nice and friendly if I was trying to scam the IRS. It was apparent that in his job he had to make calls based on his own judgment. If he had felt I was being dishonest or purposefully fraudulent he would still have been very polite but not so friendly.

He was not "out to get me" and never sprouted horns and fangs. In other circumstances he might be the federal equivalent of Hannibal Lecter and served your financial liver up with fava beans and a nice Chianti, but for the average taxpayer he was exactly what you hope your tax dollars are being spent on: a true public servant who is both knowledgeable and as helpful as the situation allows.

Did he have any idea about how the writing and publishing business works? No, but he knew a more about it by the time I left.

LESSON EIGHT: Don't be afraid to talk about your involvement in your business. I don't think it hurts and it probably helps.

The outcome? Remember all those things I had proof of but was kicking myself over for not taking? He added them all up, pointed out where I had cheated myself out of $17 for a child tax credit, re-figured the lot and, the IRS cheerfully decided they owed me $72.

LESSON NINE: Sometimes truth, justice, and the American way really do triumph.

If you do your own taxes, you need to be well-informed concerning what is and is not considered deductible to start with. You must conduct your writing-related business in a businesslike way. Taxes are a serious business, but so is yours.

I have been filing Schedule Cs since 1997. I am not an accountant or an expert on taxes, but I have taken the time to read and learn. I'd love to earn so much from my writing- and publishing-related work to hire professional help. But, even if I did, I live in an area where finding someone who can provide the specialized assistance writers (and other artists) need may not be easy to find. Unless you live near New York or Los Angeles, this might be the case for you, too.

Writers face special problems regarding business expenses. At some point I *must* have learned about Uniform Capitalization Rules [26U.S.CodeSection263A(h)], although I can't tell you when. Nor would I have thought to point it out to you now, even though I have been basing some deductions on it. The reason I mention it now is because my auditor took one of his fat tax-law books from the shelf and pointed it out to me. According to the Uniform Capitalization Rules, most businesses are required to match expenses with income. Writers, who often sustain expenses long before the income for a project comes in, are allowed to deduct project costs in the same year they are incurred.

LESSON TEN: Even if you are hiring a tax advisor, you still need to know enough to look out for your own interests.

Remember, too, that anyone who is self-employed and earns net income rather than having a loss must file "Schedule SE -- Self-Employment Tax." The self-employment tax is roughly equivalent to the social security and Medicare taxes withheld from the pay of most wage earners. You can deduct half of your SE tax when figuring your adjusted gross income. I misunderstood the SE tax the first year I earned income from the writing biz. It eventually resulted in me having to pay $891.33 in interest and penalties in addition to what I owed in taxes.

LESSON ELEVEN: Even if you are fairly knowledgeable about your taxes, you can make mistakes. If you do, accept the fact and pay up.

I hope I never have to go through an audit again. Even though my experience with the audit itself was pleasant, I did have to spend a great deal of time getting ready for it. (And it is one reason this newsletter is later than usual this month.) I also experienced some stress I could have done without. I'm pretty sure some of my family and friends could have done without my reaction to the stress. But the entire income tax filing process can be made less stressful and time consuming by keeping every receipt and a good record of every possible business expense. If I ever find the time, I'm going to learn to use software that can help me do so.

Oh, and one more thing --

LESSON TWELVE: Be honest. It's easier.

Copyright (c) 2004 Writers on the Net. This feature was originally published in "Writers.com," the monthly electronic newsletter of Writers on the Net. This publication may not be reproduced in print or posted elsewhere on the Web or used in any other fashion, in whole or in part, without written permission from Writers on the Net/Writers.com. Subscribe here or by emailing writers@writers.com.

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