Tax Court Holds That Distinguished Artist’s Work Was Not a Hobby
This tax court case is interesting and important to me because I have many friends, family and clients that are artists.
The taxpayer’s work as an artist was not a hobby and, thus, the losses from her artist business were not limited by the hobby loss rules; however, the court left for another day a decision on whether the taxpayer’s expenses were deductible as ordinary and necessary business expenses. Crile v. Comm’r, T.C. Memo. 2014-202 (10/2/14).
Susan Crile has had a long, varied, and distinguished career as an artist. She has worked for more than 40 years in media that include oil, acrylic, charcoal, pastels, printmaking, lithograph, woodcut, and silkscreen. Her artwork hangs in the permanent collections of at least 25 museums including the Metropolitan Museum of Art, the Guggenheim Museum, the Brooklyn Museum of Art, the Phillips Collection, the Hirshhorn Museum, and art museums at eight colleges and universities. Many prominent corporations, law firms, and government entities have purchased her artwork as well. She is also a full-time tenured professor of studio art at Hunter College in New York City.
During the years at issue, 2004-2009, Susan actively marketed her artwork and was represented by galleries.
She supplemented the galleries’ efforts by sending exhibition announcements and other promotional materials to her mailing list of nearly 3,000 collectors. She regularly attended art-related events to network with collectors, journalists, and art professionals. She sold, directly or through galleries, a total of 356 works of art during 1971-2013. These sales generated gross proceeds of approximately $1,197,150. After subtracting gallery commissions and other deductions, Susan earned income of approximately $668,000 from sales of her art during these years. Despite substantial gross receipts, Susan has never reported a net profit from her art business.
For tax years 2004-2009, Susan reported wage income between $86,000 and $106,000, and she reported other taxable income (interest, dividends, capital gains, pensions, and social security payments) between $17,700 and $67,000. On her Schedules C, she reported income and claimed the expenses as deductions in connection with her activity as an artist during the years at issue, including expenses for travel, meals, entertainment, mortgage and utilities.
The IRS assessed a deficiency against Susan for years 2004-2009. First, the IRS determined that Susan’s activity as an artist was an activity not engaged in for profit within the meaning of Code Sec. 183 and hence, she was not entitled to claim deductions in excess of the income she derived from her artist activity. Second, if Susan was engaged in a trade or business during the years at issue, the IRS contended that many of the deductions she claimed were not ordinary and necessary expenses incurred in carrying on that business.
The Tax Court rejected the IRS’s argument that Susan’s work as an artist was a hobby and held that that she was engaged in the trade or business of being an artist. In reaching its conclusion, the court evaluated the nine factors in Reg. Sec. 1.183-2(b) that are relevant in ascertaining whether a taxpayer conducted an activity with the intent to earn a profit.
According to the court:
(1) Susan’s marketing efforts demonstrated a profit objective and showed that she conducted her art activity in a business-like manner;
(2) Susan was without doubt an expert artist who understood the economics of her business;
(3) because Susan devoted roughly 30 hours per week to her art business during the academic year and worked on her art full time during the summer, she devoted substantial time and effort to her art business;
(4) Susan entertained a reasonable expectation that her artwork, over the course of her career, would appreciate significantly in value, and this expectation explained her willingness to continue to sustain operating losses;
(5) as far as Susan’s success in other activities, the court found that factor to be of limited relevance but, to the extent it was relevant, it favored Susan;
(6) Susan’s history of losses favored the IRS’s position although the court was convinced that such losses did not negate Susan’s actual and honest intent to profit from the sale of her art;
(7) Susan’s minimal profits weighed in the IRS’s favor but not terribly heavily;
(8) with respect to the factor of Susan’s financial status and whether she lacked substantial income or capital from other sources than artist activity, the court said this factor was neutral; and
(9) Susan’s enjoyment of her art activity was not sufficient to cause it to be classified as a hobby rather than a business.
The Tax Court did not address the IRS’s second argument, saying the IRS’s contentions concerning the substantiation of Susan’s expenses, the character of those expenses as ordinary and necessary, and her liability for penalties and additions to tax would be resolved later.
– Mark S Gleason CPA