Are You a Hobbyist or in Business?
Don’t Let the Government Decide for You
It is all well and good to say artists need to be businesslike rather than bohemian. However, those who want the IRS to accept work-related deductions like price of materials, studio rent and insurance, travel expenses, advertising and promotion, photography, postage, shipping, and other costs on their federal tax returns do not have a choice.
That is because, if the IRS believes someone is just a hobbyist rather than in business, those deductions will not be allowed. “The IRS has rules about hobbyists versus professionals,” said New York City accountant Steven Zelin. “Basically, the IRS wants to know if the taxpayer intends to make a profit as opposed to just make art.”
Artists are in business as soon as they earn money from their work in the form of sales or grants or fees if they give a public demonstration. Some sort of transaction is required. If there is no money, there is no business. A business still may be a hobby, however, unless it is conducted in a certain way, and the difference between the two determines whether expenses may be deducted.
Understanding Business Benchmarks
There are nine criteria the IRS applies to separate professionals from hobbyists:
- Is the activity carried on in a businesslike manner?
- Does the artist intend to make the artistic activity profitable?
- Does the individual depend on income generated by the artistic work?
- Are business losses to be expected, or are they due to circumstances beyond the artist’s control?
- Are business plans changed to improve profitability?
- Does the artist have the knowledge to make the activity profitable?
- Has the artist been successful in previous professional activities?
- Does the activity generate a profit in some years, and if so, how much of one?
- Will the artist make a profit in the future?
The artist does not need to answer “yes” to every question to legitimately deduct business-related expenses. Spending more money than one takes in does not disqualify someone from claiming to be in a real profit-oriented business. “In every business, you expect to have losses in the first few years,” said New York City accountant Todd Thurston.
What To Provide for Proof
The IRS demands proof that an artist made a genuine effort to earn a profit in three years out of a five-year span. If an artist has had three consecutive years of losses, the federal agency will want to see some sort of profit in the next year. “Losses that an artist has already taken won’t be challenged” if an audit takes place, Thurston said, “only losses claimed going forward.”
Zelin noted that creating a business plan, which a company or sole proprietor would need when applying for a bank loan, is useful if the IRS needs proof of an artist’s profit-making intent. This document might feature an executive summary (the nature of the business and the expectation of earnings), a description of the business operations (the studio, how much time is spent in the studio every day or every week, how artwork is transported to one site or another, the website, exhibition venues, how payment is accepted), staffing and management (a studio assistant, a business manager), revenue forecasts, a marketing plan (how the artwork produced will be made known to prospective buyers), expected expenses, and expected milestones (exhibitions, grant awards, prizes).
How To Answer When Intent Is Questioned
The IRS does not define what makes an artist a professional, but certain elements help determine whether there is a serious intent to earn a profit. “Having a BFA is something, having an MFA is more,” said New York accountant Susan Lee. “Having a website helps, especially if the website is set up for making sales, as is having a separate business credit card and business bank account. Using the services of a lawyer or an accountant in setting up or running your business shows you are serious. Belonging to an artist organization, subscribing to an industry-related magazine, or going to professional conferences is helpful, because it builds a picture of you doing everything you can do to be on top of the market.”
When To Take It to Court
If an artist believes the IRS has unfairly denied tax deductions for business-related expenses, he or she may challenge the auditor’s decision in the U.S. Tax Court, which requires petitioning the court and paying a $60 filing fee within 90 days of receiving the IRS’ Notice of Deficiency. Forms and instructions are available at www.ustaxcourt.gov.
Tax Court generally operates in the manner of a small claims court — there is no jury, and taxpayers tell the judge their story. However, many applicants to the Tax Court hire lawyers to represent them.
Artists have gone to Tax Court with claims that they are not just hobbyists and won. In 1977, a precedent-setting decision was handed down regarding painter Gloria Churchman, who had claimed losses of several hundred dollars in her tax filings in 1970 and 1971.
For all of her 20-year career, Churchman’s income from art sales never exceeded her losses, and the IRS claimed the artist was supported by her husband, a college professor. As a result, IRS auditors labeled Churchman a hobbyist and her deductions for art-related expenses were denied.
However, when the artist took her case to Tax Court, it was ruled that Churchman pursued her art career “with a bona fide intention and expectation of making a profit” and the fact that she did not rely on sales of her artwork for her livelihood was irrelevant. Lack of income, the Court ruled, and “a history of losses is less persuasive in the art field than it might be in other fields because the archetypal ‘struggling artist’ must first achieve public acclaim before her serious work will command a price sufficient to provide her with a profit.”
More recently, New York painter and Hunter College art professor Susan Crile successfully challenged an IRS auditor’s rejection of her claimed deductions on her tax returns for art-related expenses on the basis that her work as an artist was “an activity not engaged in for profit.”
Noting she had received fellowships from the National Endowment for the Arts in 1982 and 1989 and that more than two dozen museums had her work in their collections, including the Metropolitan Museum of Art, the Hirshhorn Museum and Sculpture Garden, and the Phillips Collection, the Tax Court ruled, “In a qualitative as well as a quantitative sense, we conclude that the balance of factors favors [Crile] and that she has met her burden of proving that in carrying on her activity as an artist, she had an actual and honest objective of making a profit. We therefore hold that she was … in the ‘trade or business’ of being an artist.”