Five Legitimate Reasons Celebrities Have Tax Troubles

Lynette Khalfani-CoxIn light of actor and rapper Ja Rule pleading guilty to tax evasion, and becoming the latest in a string of celebrities with tax troubles, many people are no doubt asking: "Why can't celebrities pay their taxes like the rest of us?"

But before we all jump on the kick-a-celebrity-while-he's-down bandwagon, a few important points are worth noting.
Despite all the bling and the perceived glamor that comes with being an A-lister (or even a D-lister), the truth is that it's tough being a celebrity and keeping your finances straight. Here are five reasons why the rich and famous get into trouble with Uncle Sam, including some reasons that don't make them criminals or financial fools:

1. Financial Advisers Gone Wild

First, there's the issue of financial oversight. If you trust the wrong people to handle your money or to give you financial advice, you can pretty much kiss your cash and assets goodbye. The "wrong people" in the financial world can be anyone from an incompetent accountant to a shady investment broker. From actors Nicolas Cage to Wesley Snipes, many Hollywood types have pointed a finger at the financial experts in their corner that were supposed to be watching over their financial affairs.

And lest we simply blame celebrities for their picks and say they should have known better, or picked better experts, consider this question: What's the difference between celebrities who get burned by financial advisers and the sophisticated investors who routinely get duped by scheming con artists like Bernie Madoff? Not much difference, in my opinion, since both sets of clients lost money due to someone else's wrongdoing.

2. Celebrities are Bigger Targets

Being a celebrity means, of course, that you're constantly in the spotlight. That additional scrutiny doesn't just come from the public or the media. Celebrities, with their "I'm-living-large" lifestyles and their outsized paychecks, are also prime targets for their IRS and the feds.

In fact, if you're a public figure who is routinely taking home checks in the high six figures – or even earning a seven and eight-figure income – you can pretty much put a bull's-eye on your back when it comes to the Tax Man. The IRS itself has said as much, basically confirming in public statements that it continues to more aggressively pursue high-profile cases of suspected tax avoidance or evasion. Simply put, the IRS knows it can make an example out of celebrities, unlike Average Joes.

3. Erratic Pay Cycles and Windfalls

I know it seems like a great thing to take home a million-dollar plus paycheck for singing a song, starring in a TV show or making a movie. And I'm sure the financial perks and other benefits of stardom aren't lost on celebrities. But think for a moment about what it must be like to get one or two big checks a year (either lump sums, advances or royalties) and then have to manage that money wisely all year long, maybe not knowing when the next check will come in.

Most people in the U.S. are wage earners who get regular checks once a week or once every two weeks. Some employees, like teachers, might get paid once a month. But overall, the average person who's working can count on a pretty steady pay cycle.

That's not the case for celebrities. Sure, they get their paydays – big ones, in fact. But when they get paid it's like receiving a huge financial windfall. And we all know what happens with most windfalls. People tend to blow the money.

But let's not bash celebs for that, because that would be a case of the pot calling the kettle black. Right now, millions of Americans are getting their own version of a financial windfall – in the form of an income tax refund check from the IRS. The average tax refund check is more than $3,100. But I ask you: how many people will blow that money, spending it on all manner of things? More than a few, I can assure you. Same thing happens with lottery winners who get millions.

My point is that the average American is sorely lacking in money-management skills and basic financial literacy. That's why, when most people do come into a chunk of money, it tends to get squandered. So why should we expect celebrities to do any different? Simply because their checks are bigger? It doesn't work that way. Their expenses are bigger too; in many cases, way bigger than most people can imagine.

4. Their Taxes Aren't Automatically Deducted

Also, unlike the average W-2 employee, celebrities don't have taxes automatically taken out of their paychecks. Ditto for small business owners and entrepreneurs like myself. I know what it's like to have to write a big check because you didn't pay enough in taxes during the year. And thank God I've had the money to do it – without winding up on Page Six or being slapped with a tax lien.

But I'd be willing to bet money that if the typical U.S. worker didn't have taxes automatically taken out his or her paycheck – and had to set aside cash for taxes on their own – the overwhelming majority of people would wind up in trouble with the IRS.

Right now, 70% of all taxpayers receive an income tax refund. About 25% of tax-filers pay the government each year, and that payment averages about $5,000. If you had to write a check for $5,000 because Uncle Sam demanded it – right now! – would you be able to do it? Now ask yourself this: what would happen if the IRS said you owed $50,000 or even $500,000? That's what it's like for celebrities when a notice and demand for payment from the IRS comes their way.

5. The IRS Collection System is Rigged Against Celebrities

Lastly, the very way in which the IRS collection system works is highly rigged against the celebrity and high-income earner who owes taxes.

Here's why.

If you or I owe $25,000 or less in combined taxes, penalties and interest to the IRS, we can pretty much fly under the radar with our tax issues, and nobody will ever know about it.

That's because anyone who owes $25,000 or less can automatically go into a payment plan with the IRS and pay the money off over a period of up to four years. The process is simple and straightforward. You just submit an Online Payment Agreement Application and get immediate notification of an approval for your payment agreement. You never even have to talk to anyone from the IRS because your acceptance into this repayment plan is virtually guaranteed (provided you don't owe any other taxes, and meet a few other conditions).

But once you get above that $25,000 – and virtually all high-earning celebrities have tax bills in excess of $25,000 – your options for compromising and working out a deal with the IRS are greatly reduced. You can more easily get hit with a tax lien. You must turn over a laundry list of financial records – documenting all your assets, savings accounts, expenses, etc. – if you want to get some kind of payment plan worked out.

Plus, when the IRS is trying to collect money, IRS agents look at everyone – celebrities and laypersons alike – and lump us all together. The IRS comes up with an "average" cost of things, such as the "average" mortgage bill, the average car payment and so on. If a celebrity's mortgage exceeds the average, those higher-than-average costs are, in essence, thrown out and disregarded by the IRS.

So in effect, the IRS might look at a celebrity's overall financial picture and say: "You're making $1 million a year, you should have "X" amount of cash flow," without taking into account that the celebrity has a $7,000-a-month mortgage -- not the average $2,000-a-month mortgage, for example. Additionally, the IRS could care less about certain non-IRS debts that a celebrity (or anyone else) owes; that's your problem, they figure.

Other tactics used by the IRS – such as tax liens – also more severely affect celebrities, yet don't reap any additional money for the agency. Even the IRS Taxpayer Advocate Nina Olson has said that the IRS's collection methods are punitive and need to be revamped.

In her 2010 Annual Report to Congress, Olson highlighted a number of taxpayer rights issues that she feels are problematic, including the IRS:

  • Failing to have policies and procedures that adequately protect taxpayers with an economic hardship
  • Disregarding or ignoring a non-IRS debt when analyzing a taxpayer's ability to repay an IRS bill
  • Depriving taxpayers of their right to have their cases fully considered because of a lack of due process with collections
With these issues and more being a reality, it's little wonder that it seems like every other week we hear about a celebrity being hit with an IRS tax lien.

For the record, I don't give celebrities who don't pay their taxes a pass. I think we all should pay what we legally owe: including those whose work puts them on the big screen, the sports field or in the recording studio.

But I do have sympathy for anyone facing financial woes. And I do have an understanding of the multitude of reasons that celebrities wind up with tax issues. Now you should too.

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