Tax Hope for Long Island Artists
Long Island is a beautiful place that serves as the inspirational home to many visual and performing artists, writers and composers. However, being able to earn a living in the arts often takes many years of work, especially on Long Island with its high cost of living.
Talented and dedicated artists often have to take another job to make a living for many years before earning an adequate income from their artistic endeavors. Compensation from this other work allows the artists to invest their lives, time and money in their true vocations in the arts until they become profitable.
This is widely accepted as common knowledge, except in the world of income taxation.
A typical artist’s income tax return may report a salary or other taxable sources of income offset by losses on a Schedule C for the business of being an artist or performer. The resulting tax benefit can be considerable. If, however, the loss is disallowed on audit a few years after the tax return is filed then penalties and interest can magnify the burden of repayment.
The disallowance is frequently based on the Internal Revenue Code definition that a business is an activity entered into for profit, which is demonstrated by showing a profit for three years of a consecutive five-year period (with the exception of breeding race horses, or certain other elections).
If the auditor deems that an activity is not engaged in for profit, the losses are treated as “hobby losses” and are only allowed to be deducted as Miscellaneous Itemized Deductions up to the amount of income that is earned.
A recent United States Tax Court ruling in the case of Susan Crile may prove a valuable precedent for artists who are frequent targets of audit.
Susan Crile is a high-profile artist who has sold many of her works of art during her 40-year career. During this time, however, her expenses have far exceeded her income from sales of her artwork. She has supported herself as a college professor throughout this period, and reduced her taxable income by claiming losses from her business as an artist.
Based on her lack of profit in most years of her career and lack of a written business plan, the IRS contended that her profession is teaching, and her artwork expenses are merely Unreimbursed Business Expenses. These are Miscellaneous Itemized Deductions that provide far less tax benefit than Schedule C losses.
A critical argument in Ms. Crile’s defense was that “Art is not a business like other businesses,” and other factors than profitability in three of five years should be considered. The Tax Court’s acceptance of this defining and winning argument should offer hope that the IRS may apply a fresh approach to its audits of other artists.
While artists should appreciate such a change in approach, they should not take it to mean that the IRS will allow all deductions that an artist might claim. Deductible business expenses must be “ordinary and necessary” in the context of the business. They should be documented contemporaneously, and they must be distinguishable from the artist’s necessary personal living expenses.
We urge all artists to keep business records such as diaries of their business activities, orderly files of receipts, contracts and correspondence, and avoid crossing that fine line between claiming all allowable expenses and all expenses.