Once in a while, we hear in the news that a celebrity owes the IRS millions of dollars or is facing criminal prosecution for failure to pay taxes. Celebrities are public figures, so if the press finds out about an extravagant lifestyle of a high-profile celebrity and that individual files a tax return reporting modest income, the authorities may take a closer look. Celebrity tax planning can be very complex, but even with the best advisors, there are many unclear answers.

Inside Counsel sat down with Brad Cohen, partner at Jeffer Mangels Butler & Mitchell, who's practice emphasizes business planning related to complex corporate and partnership transactions, including mergers and acquisitions, financing and business succession planning, income tax planning, and estate tax planning, all on an integrated basis.

Oftentimes, celebrities are working in multiple locations within and outside the United States, which provides tax complexities and opportunities that the IRS likes to keep an eye on. The financial lives and contracts for services of celebrities often involve many different streams of income, many of which are contingent upon successes of an entertainment property.

“For example, copyrights, royalties, back end participations, equity; each have their own unique tax rules and planning opportunities,” explained Cohen. “This provides the celebrity advisors with lots of places for interpretation and misinterpretation. In addition, many celebrities loan out their services through wholly owned personal services corporations. This adds additional tax opportunities and hazards.”

The IRS never misses the opportunity to use unpaid celebrity taxes as a promotional tool to improve tax compliance, according to Cohen. The taxing authorities have limited resources and if they can publish a celebrity's tax missteps, they hope that this will deter the rest of us mortals from mirroring that bad behavior.

“When celebrities come up short on their taxes, the world takes notice,” he said. “Headlines start running in the press that proclaim a star's money or legal troubles and they often wind up on lists in the gossip columns and online.”

If the press picks up on an extravagant lifestyle of a high-profile singer, actor, athlete, or other celebrity and that individual files a tax return on which they report an inadequate income, the IRS or other taxing authorities may take a closer look. The IRS and various state agencies are readers and watch television. If their suspicions are aroused, they may take a closer look. Cohen's advice is to strongly discourage the celebrities from appearing on shows like, “Lifestyles of the Rich and Famous”.

“Despite rumors to the contrary, the taxing authorities are human beings,” he explained. “They want to touch paper that the celebrities touch; and if they can get a face-to-face interview, that could be a career highlight.”

The financial lives and contracts of celebrities are complicated, often involve many different streams of income, many of which are deferred and contingent upon successes of an entertainment property, per Cohen. Celebrities read the headlines describing how much money they are making on a project and sometimes mistakenly believe that the reported gross compensation is available for their consumption. However, after payment to agents, managers, business managers and entertainment lawyers there is only a modest amount of cash available to maintain their extravagant lifestyles and pay their taxes.

“Celebrities frequently have enormous personal lifestyles expenses that enhance their public/professional image,” he said. “Examples of these expenses are entertainment, private aircraft, security and wardrobe. Often, their professionals will attempt to deduct those expense from their income. Not surprisingly, the taxing authorities are obsessed with auditing those expenses and often seek to partially or wholly disallow the expenses as personal and not business.”