Cutting Costs: Tax Deductions for Artists
Under the Internal Revenue Code § 183, individuals or corporations cannot take deductions for activities if “such activity is not engaged in for profit.” The IRS does not want to provide a subsidy for people engaging in hobbies for their own enjoyment; deductions are meant to accurately reflect the costs that individuals and corporations incur in the course of doing business.
But what does it mean to “engage in an activity for profit”? With the possibility of deductions on the line, many people would be tempted to argue that various endeavors are engaged in “for profit.” Should the size of the expected profit matter? Should the fact that expectations of profit are rational matter? The standard outlined in the Internal Revenue Code is “ordinary and necessary” business expenses, which in common English is typically defined as those expenses that are appropriate and helpful in running business. But even this definition is extremely vague.
The Tax Court recently examined the issue where an artist is also and an art professor. Professor Susan Crile is a tenured studio art professor at Hunter College, and her works can be found at the Metropolitan Museum of Art, the Guggenheim Museum, the Phillips Collection and other major art institutions. When Professor Crile filed her taxes she routinely deducted for the costs that went into her art production, even though she only made a profit for two taxable years. Each other year she suffered losses from the costs of creating art.
The IRS argued that because three out of 20 plus years were profitable, and because Professor Crile earned substantial annual income from her professorship, she could not claim to be engaged in art “for a profit” and could not deduct her art expenses. Professor Crile responded that she was an artist long before she became a professor and that art, unlike other occupations, is uniquely prone to the vacillating whims of the market and should be treated differently than other types of business.
To evaluate 183 claims, the IRS typically employs nine factors:
- Manner in Which Activity is Conducted
The IRS examines whether the taxpayer keeps accurate records of costs and revenues. The more detailed the record, the more closely the activity resembles a business as opposed to a hobby that might be more loosely structured.
- Expertise of Taxpayers and Advisors
The IRS looks at the level of expertise that the taxpayer has in the particular area that the taxpayer is engaged in. Is the taxpayer a beginner to this area or is the taxpayer considered to be expert within this field?
- Taxpayer Time and Effort
The IRS evaluates the amount of time and effort that the taxpayer expends on the activity.
- Expectation of Appreciation in Value
If the taxpayer does not make a profit in a given year, is there a reasonable expectation that the taxpayer will make a profit in the following years? Is there a market for the work that the taxpayer is engaged in?
- Taxpayer’s Success in Other Activities
If the taxpayer is reliant on other areas to finance the taxpayer that a stronger indication that the financially sound activities might be the true “for profit” activities and the unprofitable activities might only be hobbies.
- History of Income and Loss
The IRS looks at the patterns for how much revenue and costs the taxpayer incurs in the activity and how these numbers have changed historically.
- Amount of Occasional Profits
How many years has the taxpayer actually made a profit while engaged in this activity?
- Taxpayer’s Financial Status
This evaluates how dependent the taxpayer is on the financial success of the activity. If the taxpayer is more dependent, that is a strong indicator that the activity is engaged in for profit.
- Elements of Personal Pleasure
The IRS analyzes the extent to which the activity contains “large personal elements” to see if it is simply a pleasurable hobby.
The Tax Court concluded that IRS won on criteria 6 and 7, but the remaining criteria were favorable (or at least neutral) towards the taxpayer, and Professor Crile could classify her art as a valid profit-seeking activity and deduct for the valid costs. While the taxpayer will still need to prove that the claimed deductions were appropriately in pursuit of creating art, this case should prove important for future cases. We still may not know to what extent the individual factors need to be satisfied, but it’s clear that favorable tax treatment doesn’t require that artists satisfy every factor.
Amy Rosenthal is a J.D. candidate, ’16, at the NYU School of Law.