By: Kelly Richardson
Since Congress enacted the Tax Reform Act of 1969, section 183 has uniquely affected a variety of individuals.[1] This statute, commonly called the Hobby Loss statute, allows a participant to deduct the cost of engaging in a hobby only to the extent that it does not exceed the profits derived from that hobby, unless the participant is engaging in that hobby as a business or trade.[2] If the individual engages in a hobby for business or trade, then he/she can deduct all of his/her losses in accordance with the rest of the code.[3] Given that a taxpayer can deduct an ordinary and necessary business expense paid or incurred in carrying on a trade or business,[4] it would be beneficial for a taxpayer to deduct their losses as a business expense and not as a hobby loss.[5]
The IRS regulations identify nine factors that indicate whether a participant is conducting an activity as a business.[6] The nine factors are 1) the manner in which the taxpayer carries on the activity; 2) the expertise of the taxpayer or his or her advisors; 3) the time and effort the taxpayer expends in carrying on the activity; 4) an expectation that the activity’s assets will appreciate in value; 5) the success of the taxpayer in carrying on other similar or dissimilar activities; 6) the taxpayer’s history of income or losses with respect to the activity; 7) the activity’s profits; 8) the financial status of the taxpayer; and 9) elements of personal pleasure or recreation.[7] While it is not necessary that a taxpayer answer all of the factors affirmatively, courts evaluate each factor in the aggregate.[8]Since no single factor controls whether a participant is engaging in an activity for profit, courts primarily use objective facts that support the taxpayer’s intent.[9]
Yet, in today’s world filled with endless dreamers, those who choose to dedicate their life’s work to their chosen art craft are unintentionally penalized.[10] There are many reasons why the nine factors listed in section 183 do not accurately portray whether an artist is engaging in an activity for profit.[11] For the vast majority of artists, art is a business or trade where they need to have an alternative source of steady income.[12] While courts have held that a taxpayer can engage in more than one business or trade.[13] A taxpayer engaging in activities where they cannot sustain themselves financially is indicative of a hobby. Additionally, there is no uniform and objective test for assessing expertise, or the ability for courts to measure the inherent personal enjoyment that artists derive from their work.
However, artists are not out of luck. They can manifest their intentions to participate as a professional by strategically engaging in the arts. First, an artist must maintain records of his/ her sales and purchases similar to the way a local shop does.[14] Second, an artist must commit to a routine.[15] Committing to a routine indicates that an artist is invested in the success of his/her brand and a motive of creating profits. Lastly, an artist must have a business plan to expand his/her potential market.[16] Artists face an uphill battle, but with a well designed business plan, section 183 can elevate some of their financial burdens.
[1] Tax Reform Act of 1969, Pub. L. No. 91-172, 83 Stat. 487 (current version at 26 U.S.C. 183 (2014)); Tony Nitti, How Not to Run Side Business: Navigating the Hobby Loss Rules, Forbes, (Oct. 23, 2015),https://www.forbes.com/sites/anthonynitti/2013/07/22/how-not-to-run-a-side-business-navigating-the-hobby-loss-rules/2/.
[2] See 26 U.S.C. 183(b)(2) (2014).
[3] Id.
[4] Id. § 162(a) (2015) (allowing taxpayers to take a deduction if the taxpayer is involved in the activity with continuity and regularity and their primary purpose is to engage in the activity to produce a profit).
[5] See id.
[6] 26 C.F.R. § 1.183-2 (b)(1)-(9) (2015).
[7] Id.
[8] Storey vs. Comm’r, 103 T.C.M. (CCH) 1631, 1633 (2012).
[9] See id.; see also Crile v. Comm’r, 108 T.C.M. (CCH) 372, 375 (2014).
[10] See Elena Sheppard, For Millennials, It’s Not Practical, N.Y.Times, (November 8, 2013),https://www.nytimes.com/roomfordebate/2013/11/07/the-cost-of-being-an-artist/for-millennials-being-an-artist-isnt-practical.
[11] See 26 C.F.R. § 1.183-2 (b)(1)-(9) (2015).
[12] See Crile v. Comm’r, 108 T.C.M. (CCH) 372, 373 (2014) (stating that a tenured art professor was engaging in an activity for profit when she conducted her artistry); Storey vs. Comm’r, 103 T.C.M. (CCH) 1631, 1662 (2012 (adjudicating that the taxpayer who was a partner at a law firm, was engaging in an activity for profit when she decided to deduct her losses from a documentary she created).
[13] Storey, 103 T.C.M. at 1662.
[14] See id.
[15] See id.
[16] Crile, 108 T.C.M. at 373