Profession or Mere Hobby? Don’t Let the IRS Decide
Section §183 (“Activities Not Engaged in For Profit”) of the Internal Revenue Code is frequently called the “Hobby Loss” exception. This is an exception to the rule that business owners may deduct reasonable business expenses on their tax return. The IRS severely limits deductions taxpayers may make when the expenses involve a “hobby” that the taxpayer does for personal enjoyment and is not meant to be the taxpayer’s main source of income. The idea behind the exception is to prevent taxpayers from deducting expenses from what is truly a hobby in order to underpay their federal income tax. Unfortunately, the IRS has a tendency to target independent artists, determining that an artist’s career is merely a hobby and not a true profession. This includes not just visual artists but musicians, writers, and dancers as well.
So how do artists protect themselves against a potential ruling that their profession is not a mere hobby? The most important case regarding an artist and business deductions is Crile v. Commissioner. Crile had been a professional visual artist for decades. Because of her reputation, Crile was given a teaching position at a liberal arts college. The IRS argued that her work as an artist was merely that of a hobbyist, despite her long track record of sales, gallery shows, and awards. The IRS even tried to argue that the teaching position was her true profession, and not her work as an artist which got her the teaching job in the first place! The IRS lost the case. The court looked at a series of factors to determine whether Crile’s work as an artist constituted a profession and not a hobby. The IRS has since adopted those factors in its guidance under §183. No one factor will determine whether something is a profession or a hobby. All of the factors are weighed.
Is the activity carried on in a businesslike manner and does the artist maintain complete and accurate books and records?
Are there personal motives in carrying on the activity?
What is the time and effort the artist put into the activity to indicate they intend to make it profitable?
Does the artist depend on income from the activity for their livelihood?
Are losses due to circumstances beyond the artist’s control (or are they normal in the startup phase of this type of business)?
Does the artist or any advisors have the knowledge needed to carry on the activity as a successful business?
Was the artist successful in making a profit in similar activities in the past?
Did the activity make a profit in some years and how much profit did it make?
Can the artist expect to make a future profit from the appreciation of the assets used in the activity?
Artists wishing to avoid a potential IRS audit would do well to adhere to these guidelines to the best of their ability. The Crile case in particular is an excellent resource as the court goes into great detail analyzing the factors and the evidence it used to show that Crile was, in fact, a professional artist and that her business deductions were reasonable.
(This article is for informational purposes only and does not constitute legal or tax advice.)