According to that IRS report, audits of high-income returns (which the IRS defined for 2005 as returns reporting annual income of $100,000 or more) had reached a 10-year high. With the Bush administration having created some of the highest federal deficits in the history of the U.S. and the adult entertainment industry continuing to enjoy huge profits, some adult-oriented businesses are bound to become targets of IRS audits — and because they fear being audited, some adult entrepreneurs may be reluctant to take every deduction they are entitled to under U.S. tax laws.
But Joshua M. Kleinman, a Los Angeles-based accountant who has his share of clients in the adult industry, asserts that there is no reason why adult businesses should be paying any more taxes than they are legally required to pay and that they should take every legal deduction they are entitled to. Kleinman, of the firm Solomon, Winnett & Rosenfield, claims that while adult businesses, like mainstream businesses, need to be prepared for the possibility of an audit (which means keeping careful records and saving all business-related receipts), they need not be cowering in fear. Instead of being paranoid, Kleinman said, they should maintain knowledgeable accountants and learn as much as they can about legal tax deductions — and the list of business-related items that are deductible is a long one.
According to Kleinman, many of the things that are typically deducted by mainstream businesses also can be deducted by adult businesses, including office supplies (pens, paper, printers, ink cartridges, envelopes, etc.), computers, software, phone calls, travel expenses and business lunches. All of those deductions have to be business-related; a two-week trip to Rio de Janeiro, for example, is tax-deductible if you are going there to shoot or acquire content but not if you are going there strictly for a vacation.
Deductions: A Target?
Despite all the parallels between mainstream business tax returns and the tax returns of adult entrepreneurs, there are certain sexually oriented items that adult businesses are more likely to deduct, and anyone in the adult industry needs to know what those items are.
Adult film and video companies, Kleinman said, can legally deduct condoms, lubricants, dildos, vibrators and sex toys if they are used in the course of filmmaking. Of course, adult businesses come in many different forms — adult webmasters, strip clubs, BDSM dungeons and sex toy manufacturers all contribute to the adult industry's economic health — and a smart accountant will be mindful of an adult company's specific tax needs.
"Different types of adult companies are going to be deducting different types of expenses," Kleinman stressed. "An adult film producer or content provider is going to have talent, crew, replication expenses and possibly some location expenses here and there; they are probably going to have a lot of legal expenses. And an adult webmaster's expenses are going to include bandwidth and equipment; he is probably going to have some legal expenses in order to make sure he is compliant with 2257, but he probably isn't going to have a legal bill as big as that of an adult film company or a content provider."
Jeff Booth, president of the L.A.-based Erotic University, a company focusing on adult sex education, noted that he is able to deduct everything from envelopes to sex toys. And Veronica Bound, who serves as curator for the Aphrodite Gallery, an erotic art gallery in Philadelphia, told XBIZ that her deductions typically include everything from basic office supplies to whips.
"Because I do kinky adult sex education classes," Bound explained, "I am able to write off a variety of sex toys, vibrators, condoms, lubes and dildos that I use in my classes for demonstration purposes. If I have to buy hemp rope for my students to use in a bondage class, that is fair game. I teach classes on sex toys, and I am able to write off the sex toys that I use in those classes. That's all completely legitimate as an educator. And since I travel to teach, I keep any travel receipts that I have in connection with my business, whether it's cab fare or airfare."
Sherri Holloway of the L.A.-based, lesbian-oriented Girlfriends Films suspects that because they are fearful of an IRS audit, some adult entrepreneurs may hesitate to take every deduction they are entitled to, which she said is regrettable, because adult businesses often need those deductions to cope with high overheads.
"The things that adult companies need to spend money on really add up," Holloway said. "It's quite expensive to run an adult film business."
Holloway added that she deducts everything from United Parcel Service expenses to douches but likes the fact that her accountant is cautious. "My CPA is always telling me to be careful and always have all my ducks in a row," Holloway said. "He strictly goes by the book, and I feel secure with him doing that. I would rather do things the right way and not worry about it. I don't deduct anything unless I have the paperwork to back it up. I account for every single DVD that goes through here."
In part two, we'll look at the audit process and beyond.