Tax Court Reaffirms That You Don’t Have to Make Money to Be in (Show) Business

Most everyone has a hobby. Some percentage of those with a hobby earn money from their efforts. Gardeners sell their prize winning roses or even the whole bush. Breeders sell their adorable Labradoodle puppies. Clients often ask us to deduct the costs associated with their hobbies on their tax returns. We are forced to reply that while the tax code allows them to take deductions up to the amount of income generated from the activity, the Internal Revenue Service (IRS) and the Courts have established some significant hurdles for hobbyists to jump in order to treat the hobby as a business and deduct all their expenses.

The tax regulations include a list of nine factors that help distinguish between a real business and an activity “not engaged in for profit.” No one factor is more important than another, and there may be other factors that are relevant to the determination. The factors are:

1. The manner in which the taxpayer carries on the activity
2. The expertise of the taxpayer or his advisers
3. The amount of time and effort devoted by the taxpayer to the activity
4. An expectation that assets used in the activity may appreciate in value
5. The taxpayer's experience in converting other unprofitable activities into profitable enterprises
6. The taxpayer's history of income or losses in the activity
7. The amount of occasional profits, if any, that are earned
8. The financial status of the taxpayer
9. Elements of personal pleasure or recreation in conducting the activity

There have been many cases over the years where the taxpayer believes they are in a business and deducts all their expenses, which the IRS then disallows. Sometimes the taxpayer wins, sometimes not.

The latest case (Gaston v. Commissioner) involves a retired national sales director for a cosmetics company who decided to take up acting to supplement her retirement income, notwithstanding the fact that very few actors actually make money from their craft. This particular actor, though, had prior experience in the entertainment industry. She also had a very successful actor daughter, Robin Wright.

The IRS said she didn’t engage in the activity for profit because she didn’t generate a profit in the years in question. The Court felt that the time spent by the taxpayer (35 to 40 hours per week) as well as hiring an assistant and an agent, doing research, and taking classes all supported the taxpayer’s position that she was in the business of acting. The opinion also notes that the effort spent in the years in question led to more, and profitable, roles in years not under examination. And, as we constantly advise clients, the taxpayer had sufficient documentation to support her position.

Moreover, the IRS asserted that she should have used her daughter’s connections to get her more roles and advance her career. The court, however, found that nepotism wasn’t one of the enumerated factors and the taxpayer had sufficient documentation to support her position. We can’t overemphasize how important good documentation is when defending a tax position from an IRS challenge. It isn’t mandatory and it doesn’t guarantee victory, but it’s certainly helpful.

Your Friedman LLP advisor can assist in turning your passion project into a business, whether your friends and family are interested in helping or not.