Certain concerns surface every year among my readers, just as some people believe every year that the stupid groundhog and his shadow actually predict how much winter is left. (Do the math: Groundhog’s Day to vernal equinox is just over six weeks. Shadow or no shadow, that’s six more weeks of winter.)

A concern that made an unusually early appearance in my office this year involves deducting professional expenses that exceed your earnings as an artist. In some cases, I seem to have caused the early arrival by talking (two issues ago) about how one associates expenses with different business activities and sources of income.

Losing Money is OK

You would rather make money than lose it, but you can’t always control the situation. And the short answer is that you can, indeed, deduct business expenses that exceed your income. United Airlines lost $2 billion last year, and nobody is suggesting that they should not deduct the business expenses that caused the loss. Why should it be any different for an actor?

What seems to make it different in the actors’ minds is the emotional content. At some level, they are often embarrassed, maybe even ashamed, at not being the big star everyone back home knew they would be. Then too, they may feel guilty: They enjoyed their work, and that’s just not how it is supposed to be.

Tell all that to your therapist. Tax law is about as emotional as an airline meal (and sometimes inspires similar loathing and disgust). Businesses are entitled to deduct all of their ordinary and necessary business expenses. Simple and to the point, if you are in business.

"If you are in business," however, is where the short answer becomes a long one.

What is a Business?

Intuitively, we all recognize a business when we see it, but formally defining it is tricky, indeed. It’s like trying to explain why you can look at a shar pei, a poodle and a beagle and know they are all dogs. Tax law does not work on intuition, but nobody has come up with a clear, concise definition of "business." Instead we have a whole bunch of rules that, taken together, serve to distinguish businesses from non-business activities.

Some of these rules, like the passive activity loss restrictions and at risk limitations, try to distinguish an actively-conducted business from an investment. The issues here are primarily those of timing: Business income and losses are recognized currently, while investment gains and losses are generally recognized only at the end of the investment (such as when you sell the stock). While important, these rules are tricky, a conceptual quagmire, and largely irrelevant to activities in the arts. If you need to know, I will be happy to explain them–just not today.

The rules that do matter for artists are the ones intended to distinguish personal expenses from business ones. Personal expenses are not deductible, business expenses are. But here, too, there is no clear line to draw.

Suppose you collect something–anything–coins, records, toy soldiers. Sooner or later, you run out of space or acquire duplicates. Depending on what you collect, you might hold a garage sale, post it on eBay or send it to Sotheby’s. When you sell it, you have income, taxable income. But this is your hobby, not a business. What about the expenses of selling and the original cost of the item you sold? To make matters fair, you can deduct the costs of any income-producing activity up to the income derived from it.

Translation: As long as you make a profit, whether you are a business does not matter. But it becomes extremely important when you have a loss.

Hobby Losses, And Why You Don’t Have Them

The difficulty of defining business is manifest in the so-called Hobby Loss rule: You can deduct losses incurred in any activity you entered into for the purpose of making a profit. Instead of cold and hard facts, this law requires that the IRS evaluate intent. Subjective judgments are not what the typical IRS staff member does well, so the higher-ups warn them off with a widely misunderstood rule: an activity which shows a profit three years out of five is presumed to be a business. But before you hastily start manipulating your numbers, note "presumed;" this is a rebuttal presumption, not an ironclad rule.

Underneath that presumption, the IRS uses nine factors (all subjective) to consider whether an activity is or is not a business. And this is an essay test most actors can easily ace, because the test revolves around three concepts. First, does the taxpayer take the activity seriously, devoting thought, time and effort to it along with the money? Second, does the taxpayer have any qualifications for the business, any training, background or experience? Even the most lackadaisical, dilettante-like actor compares favorably on these points with the dentist who buys a race horse, or the banker who deals in vintage Barbie Dolls.

The third concept scares actors a little, which is whether there is an element of personal pleasure in the activity. Puritan to the core, Americans tend to feel guilty should they be so fortunate as to like their work. But this test does not mean you must hate your work. It just recognizes that nobody will shovel manure as a hobby (though we did have a President who liked to chop wood).

And, of course, we’ve all been involved in productions where we would really rather be shoveling manure.

Free Money!

Not exactly, but you can get one for free and it might save you some money. "It" is my "Checklist of Potentially Deductible Items" for those in the arts. Just call or write my office, and we’ll be pleased to send you one.

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.

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