In the recent US case Crile v Commissioner, the IRS sought to show that the forty-year career of a well-known artist, some of whose works hang in the Metropolitan Museum of Art and the Guggenheim, was not a business, but merely a hobby.
The case turns on the following point. Relevant US law permits taxpayers to deduct the expenses of their trade or business from the taxable profits of that business. And, if the expenses are greater that the profits, then the taxpayer may generate a net loss. That loss may be of value to the taxpayer if she or he has other profits against which the loss can be set, thereby reducing the overall tax bill payable.
|Suffering is not a pre-requisite to deductibility:|
The Comic Almanack, 1847
© The Trustees of the British Museum
But if the taxpayer's activities are not a business but a "hobby", then the deduction position is different. The expenses of a hobby can be deducted against any profit it may make, but only to the extent of those profits. Where the expenses of a hobby are greater than its profits, the taxpayer is not entitled to generate a loss. This is intended to prevent a taxpayer from running a profit-making business and at the same time enjoying a loss-making hobby activity (such as horse breeding or drag racing) - and using the losses generated in their spare time to reduce their business tax bill to nil.
In the case of Crile the artist made a profit working as an art professor, but a loss working as an artist. When she sought to offset the two, the IRS argued that her losses as an artist were not allowable since her artistic production was a hobby.
In determining whether an activity is a hobby or a business, the IRS will consider whether the activity is carried on with the objective of making a profit, or whether the real objective is the taxpayer's own entertainment. In coming to a decision the IRS will apply the "hobby loss rules". These are nine different factors to be considered, such as whether the taxpayer keeps accurate books and records of the activity, how much of the taxpayer's time an activity is expended on the activity, to what extent the activity has elements of personal enjoyment or recreation and so on.
The outcome of the case, hailed as a "victory" for artists, was that the taxpayer's long and distinguished career - on which she kept detailed records, used a bookkeeper and agent, and spent much of her working time, although she typically lost money - was indeed a business. The court acknowledged that given the unusual nature of the art world, an atypical profit structure - such as a string of losses over many years, or sudden success following a successful show or review - would not necessarily be taken as evidence of a hobby. Nor would a business "be turned into a hobby merely because the owner finds it pleasurable" which is a relief - it would certainly be harsh tax result if it was necessary to dislike your own business in order for your expenses to be deductible. "Suffering," the court confirmed, "has never been made a pre-requisite to deductibility."
It has been pointed out however that the deductions which the IRS sought to disallow in this case were suspiciously large, and in some instances were of a personal nature which should not in any event have been deductible. The taxpayer's approach to deductions, the court noted, was that "most experiences an artist has may contribute to her art and that most people with whom an artist socialises may become customers or otherwise enhance her career" - on which basis she deducted a great many expenses which did not pertain directly to her career as an artist, such as cable television bills, taxis to the opera, and tips to doormen.
The IRS therefore made a twofold argument: firstly that the taxpayer's activities were a hobby and as a second (and more reasonable) line of defence that, if the activities were a business, then the expenses in question were not all "ordinary and necessary" for that business and therefore not deductible. While the court's decision as to the first argument will be a relief for US artists, the decision on the second may not be good news for this particular taxpayer.
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