Tax Tips for Adult: 2

Paul Lundgren
In part one, we began our look at tax issues and adult entertainment. In this conclusion, we'll look at deductions, the audit process and beyond:

Some adult entrepreneurs might be reluctant to deduct sexually oriented items because they don't want to broadcast to the federal or state government the fact that they are running adult businesses. But Kleinman said that there is no reason why an adult entrepreneur's federal or state tax return has to give any indication of a business' sexual nature.

"If you are operating an adult film company, you don't have to call yourself an adult film company on your return — you just identify yourself as an entertainment company," he said. "That's vague enough. And I wouldn't list condoms, lubes and dildos as condoms, lubes and dildos on a return; I would just list them as production supplies. Adult webmasters don't have to call themselves adult webmasters on their returns; they could simply say 'Internet services.' A professional dominatrix could simply list herself as a performer on her return, and she doesn't have to list whips and chains and nipple clamps on her return; she could just list those things as supplies."

Kleinman added, however, that in the event of an audit, an adult-oriented entrepreneur would need to tell the IRS about the nature of his/her business. But even if the IRS does learn that the taxpayer being audited is operating an erotic business, Kleinman stressed, it must adhere to strict federal laws governing taxpayers' privacy.

"The IRS can share taxpayer information with state and city tax agencies," Kleinman said, "but they aren't going to be sharing that information with the media or with any sort of law enforcement agency. That would be illegal."

Booth asserted that in the grand scheme of things, a typical IRS audit is not the end of the world for an adult business — certainly not compared to major concerns like obscenity prosecutions and 2257 inspections.

The Audit
"If you ever get audited," Booth said, "you will have to be able to prove that the things you are deducting were actually used in your business. If you buy a bunch of sex toys that are going to be used in an adult video and plan to deduct them, you want everything to be well documented. You want to be able to say, 'Here are the receipts for the items, and here is the adult video I used them in. This is the video that I bought those sex toys for.' That would be an interesting conversation with an IRS agent; you're showing the adult video to the agent and saying, 'OK, you see this scene where she squirts? That's where we used these items that we deducted.'"

An area where some of the smaller mom-and-pop adult webmasters may encounter problems, Booth said, is when it comes to deducting home offices.

"If you are operating an adult business out of an office building or some type of nonresidential real estate, it's clear that the property is being used exclusively for business," Booth explained. "But a lot of adult webmasters run these home-grown adult businesses out of their houses or apartments, and that is where it gets a lot trickier. If you are operating an adult website in a home office, is any of the equipment you are deducting that is being used for anything personal? That's where you can find a problem."

One of the issues that can affect young, struggling adult businesses is what accountants call "the hobby trap." If a small business is unprofitable year after year but has numerous deductions, the IRS may decide that the business is really a hobby — not a true business —and disallow a Schedule C.

"If you have someone who is reporting a couple hundred grand a year on a W2 for a regular, full-time job as, let's say, an attorney or a doctor, and they turn around and have a little Schedule C on the side that is losing 20,000 or 30,000 a year several years in a row, they can run into problems with the IRS," Kleinman explained. "Let's say, for example, that the attorney or the doctor is doing adult photography on the side; he goes to all the adult trade shows with his professional equipment and is deducting thousands of dollars every year on his Schedule C for his camera supplies and travel expenses and other things but isn't making a profit. I could see the IRS stepping in and saying: 'This isn't a business, son, it's a hobby."

The bottom line, Booth said, is that the fear of an IRS audit should not prevent adult entertainment companies from taking every legitimate deduction — legitimate being the operative word — they are allowed.

"I suppose that if an adult company gets audited, you could get audited by an IRS agent who hates adult entertainment," Booth said. "But there are things to worry about and there are things to really worry about, and if you keep good, careful records and have a good accountant, you're going to be OK. All of the things that apply to running a legitimate mainstream business also apply to running a legitimate adult business. Run an honest adult business, and you're going to be fine."

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