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Apr 26

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Filmmaker wins key victory in deducting losses

In T.C. Memo 2012-115 (April 19, 2012), a taxpayer won a notable tax case involving the hobby loss rules. The Tax Court framed the issue as follows:

 We must decide whether petitioner’s documentary film production activity was a trade or business or a labor of love. Respondent asserts that Smile ‘Til It Hurts was the latter, a labor of love motivated almost exclusively by petitioner’s desire to learn about her husband’s past and to document this exciting part of his youth. Respondent argues that petitioners are not entitled to deduct expenses from Smile ‘Til It Hurts because petitioner embarked upon her film-making journey to fulfill her curiosity, not with the intent to make a profit.”

Income Tax Regulations Section 1.183-2(b) provides nine factors which may be used to determine whether an activity is operated for profit. An objective analysis of the facts and circumstances of each case are the primary test, rather than the taxpayer’s statement of intent. Some of these tests benefit from expert accounting testimony. No one factor is determinative. The factors are:

  1. the manner in which the taxpayer carried on the activity,
  2. the expertise of the taxpayer or his or her advisers,
  3. the time and effort expended by the taxpayer in carrying on the activity,
  4. the expectation that the assets used in the activity may appreciate in value,
  5. the success of the taxpayer in carrying on other similar or dissimilar activities,
  6. the taxpayer’s history of income or loss with respect to the activity,
  7. the amount of occasional profits, if any, which are earned,
  8. the financial status of the taxpayer, and
  9. whether elements of personal pleasure or recreation are involved.

The Tax Court analyzed each of these nine factors in a detailed factual finding. The Court concluded that the documentary film was a for-profit venture and not a hobby. The Court found in favor of the taxpayer on all issues.

The case stands for the proposition that a taxpayer can have a for-profit venture even though the taxpayer has a successful full time job in another entirely unrelated venture and subject area, and has an intense personal love for the subject of the business. The case is of value to others in the arts who pursue their passion and find that their immediate efforts generate losses. The case also provides helpful precedent to businesses in other subject areas.

The Court’s analysis also emphasizes the extensive factual record that the Court considered before agreeing with the taxpayer that her efforts were not a hobby. Those who do not have extensive factual support will likely face a different result.

 

About the author

David Nolte

I am a founding principal of Fulcrum Inquiry, an accounting and economic consulting firm that performs damage analysis for commercial litigation, forensic accountings, financial investigations, and business valuations. I am a Certified Public Accountant (CPA) and an Accredited Senior Appraiser (ASA), as well as having other professional credentials. I regularly serve as an expert witness involving damages measurement. My litigation-oriented resume is on Fulcrum's website.

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