St. Louis Volunteer Lawyers & Accountants for the Arts presents
Hobby or business?
For tax purposes, activities earning profits in three of five years are normally presumed to be businesses rather than hobbies. Artists who meet the requirement can deduct their business expenses when they file their Schedule C, Profit or Loss from Business, with the IRS. If your business deductions exceed your income for the tax year, you can claim a loss, up to the amount of your taxable income from other sources.
What happens if you do not meet the three out of five-year test? Will an IRS auditor automatically consider your artistic endeavor a hobby (no deductions allowed) instead of a business? No! That’s assuming you can prove that you’re conducting your arts-related business with the clear intent of making a profit.
To help artists make a convincing case with the auditor (taxpayers bare the burden of proving profit motive), experts point to the nine factors the IRS considers in distinguishing hobbyists from professionals. Here is the IRS's list of “objective” non-exclusive factors with some tips that will not only help you make your case but also help your business grow:
- Whether you carry on your activity in a business-like manner. Maintain complete and accurate records. Keep a separate bank account and credit card for your business. Avoid co-mingling of assets, which involves using business resources for personal purposes or the business using the owner's personal resources for business purposes. Letterhead, business cards, your website, invoices, budgets, accurate books, insurance, reasonable goals and membership in professional associations also are construed as business-like behavior. Like a non-arts business, you should periodically review your sales or promotion strategies and make changes needed to improve profitability.
- Whether you (or your advisors) have the knowledge needed to carry on the activity as a successful business. Document your professional training, practices and accomplishments. Consult with experts, especially about profit potential, when appropriate.
- Whether the time and effort you spend on the activity indicates that you intend to make it profitable. Keep a log or journal to document your working time and attempts to grow the business. If, over a period of time, you are devoting more time to your artwork, you can demonstrate your sincerity even if you are not currently a full-time artist. In fact, nothing requires an activity to be the taxpayer’s sole or principal occupation.
- Whether you can expect to make a future profit from the appreciation of the assets used in the activity. Again, documentation is critical. If your sales and selling prices or fees have increased, then you can demonstrate a reasonable expectation of future profits.
- Whether the assets used in the activity may appreciate. While this factor may not apply to most arts businesses, it’s important to document any expected asset appreciation.
- Whether you have been successful in making a profit in similar activities in the past. Cite teaching, jurying, curating and writing as well as the activities covered above. Start-up losses or losses sustained due to circumstances beyond your control (such as fire, theft or depressed market conditions) will not indicate that you lack a profit motive.
- Whether the activity is profitable in some years and how much profit it makes. A long history of losses or small profits could hurt your case. Profitable years that appear artificially created could raise a red flag. So, could a loss that results in a large tax benefit.
- Whether you depend on income from the activity for your livelihood. An apparent need for the arts-related income will support your case. Conversely, wealth will not necessarily indicate lack of profit motive.
- Whether you derive personal pleasure from the activity or use it for recreational purpose. You are not required to suffer to produce your art, but you should carefully document all claims, particularly entertainment and travel expenses.
If you're audited, look at Churchman v. Commissioner [68 TC 696, 1977], a case that established a precedent for acceptance of artists as being in business without making a profit. Despite a history of losses, the artist was allowed to deduct sufficiently documented expenses.
Crile v. Commissioner [T.C. Memo 2014-202, October 2, 2014] was a victory for artists who teach. Susan Crile is a painter and a tenured professor of studio art. She attracted the IRS’s attention because of the large amount of deductions she was taking for her art business. Crile has sold hundreds of pieces during the last 40 years and has work in 25 museum collections. But the IRS argued that teaching is her actual profession. The court ruled for Crile, noting that her day job was clearly a supplement to her main vocation of painting, not the other way around. Crile’s detailed recordkeeping, the time she devoted to producing and marketing her work and a clear profit motive helped persuade the court.
St. Louis Volunteer Lawyers and Accountants for the Arts maintains a file of other hobby loss cases, which is available on request, vlaa@vlaa.org.
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