BY GREG MERMEL, CPA
Are you afraid of the bogeyman? The closet monster? The creature that reaches up from the bathtub drain and eats toes? Probably not. The typical PerformInk reader is an adult (at least chronologically), and has the irrational fears of an adult. Chief among them seems to be that the Internal Revenue Service (IRS) will tell you that you cannot deduct your expenses because you are not making enough money. "Give up show business and get a real job," you seemingly expect them to say.
But guess what? The IRS is not your uncle Nathan. Despite what you may have heard, being able to deduct your professional expenses is one of the few areas of life where trying really hard is sufficient.
Just Don’t Sing "What I Did for Love"
This pond of panic is fed, I think, by two springs. One of C.G. Jung’s psychological archetypes is a fear of being unmasked, of being labeled an imposter. People who are always confident and live on the surface, never looking inwards, do not suffer from this. People who do are introspective, constantly evaluating themselves and searching for more. Actors in particular are trained carefully to always look inwards. I am not a psychotherapist, so I cannot offer much help about this archetype other than to remind you that they don’t have bobsleds in San Juan.
But there is another source I can help you understand and deal with. That is Section 183 of the Internal Revenue Code, better known as the hobby loss rule. It will help a great deal in my explanation if, before I start, you forget everything you have ever heard about this rule–it is almost certainly wrong.
The concept is utterly simple. You can’t deduct a loss from an activity unless you undertook that activity with the intent of making a profit. And that is just what you did. You are a professional.
People exist who do their art solely for love, and truly are indifferent to the money. No matter how talented or skilled, they are properly called amateurs. Even amateurs can deduct their expenses if they happen to have some income from the activity, but only up to the amount of the income.
But How Will They Know?
What scares even the most mentally healthy actor about this rule is the phrase "intent of making a profit." Intent is hard to prove, but it is also hard to disprove. Believe me, the folks at the IRS charged with enforcing this rule do not like that phrase either. They dislike making subjective judgments, and know that they can easily result in the proverbial spitting contest between the taxpayer and the government. Dueling lawyers in a courtroom may make for good television drama, but litigation is tedious and costly in real life.
The rules and guidelines that the IRS has established to deal with Section 183 cause much confusion because they are necessarily vague in dealing with a subjective area. Above all, people are confused by the "three-out-of-five" rule.
All that rule says is that if an activity shows a profit three years out of five, the IRS will generally presume it is a business. This is nothing more than a coarse screen, so that cyclical businesses need not worry about the rule. Think airlines, or auto manufacturers. The key word is "presume." It is designed to focus the IRS’s attention, and not to provide absolute protection. If the IRS should raise a question, your having shown a fifty dollar profit in three years and a $25,000 loss in the other two will not protect you. Fear not, though, for other considerations will.
The List
IRS regulations list nine factors to be considered in trying to discern the taxpayer’s intent. Apply your scene study and character analysis skills, and I think you will agree that they are pretty good external indicators of a person’s underlying intent:
• "manner in which the activity is conducted." Do you keep records? Charge a fair price? Act like a business?
• "expertise of the taxpayer or his adviser." You probably have a diploma that proves you know what you’re doing. (See Jung discussion, above.)
• "time and effort the taxpayer spends on the activity." Enough said.
• "taxpayer’s history of income or losses with respect to the activity." So what if you haven’t worked much since your television series was cancelled five years ago.
•. "the amount of profits." Remember what I just said about fifty dollar profits?
• "taxpayer’s finances." How much hardship and sacrifice do these losses require?
• "elements of personal pleasure or recreation." Before you say a naughty word, let me point out that the appellate court cases on this factor mostly involve racehorses, yachts or farms.
The last two factors do not really apply in the arts:
• "taxpayer’s success in similar or dissimilar activities." Translation: If you have started successful businesses before, they do not have to be in the same field as what you are doing now.
• "expectation that assets used in the activity may appreciate in value." Selling used tap shoes at a celebrity auction doesn’t count.
Don’t Sweat It
You can’t just go yes-or-no to each factor and count the results. The answers as a whole have to be evaluated and a judgment made by the IRS. This is why there are lots and lots of court cases about hobby losses.
But I can’t find even one case involving a performer, and only one rather silly one involving a writer. You are not the IRS’s target.
Now, about that funny look the director had on his face during your callback...
Are there money or tax questions you would like to see discussed in this column? Let me know, at 2835 N. Sheffield, Suite 311, Chicago, IL 60657, or 773/525-1778 (888/525-1778 outside the Chicago area).
Greg Mermel is a certified public accountant whose clients in the arts range from individual performers to major theatre companies and suppliers. He also sometimes produces theatre.