Tax information for artists…
This information is provided to assist you. Be advised, SMAL is not an authority on taxes. The following may be useful to read before having a conversation with your individual tax advisor.
Most of us have a sales tax number, so we have filed our report and paid the tax on any related sales. Those sales will need to be included in our gross income, so it might help to know how to post the expense deductions.
If the artist can justify filing as a businesses they would use Schedule C, and hobbyists would use Schedule A.
Is it a Business or a Hobby? A key feature of a business is that you do it to make a profit. You often engage in a hobby for sport or recreation, not to make a profit. You should consider nine factors when you determine whether your activity is a hobby. Make sure to base your determination on all the facts and circumstances of your situation. For more about ‘not-for-profit’ rules see Publication 535, Business Expenses. (The nine factors are below)
Hobby vs. Business
For tax purposes, a hobby is defined as an activity that you engage in “for sport or recreation, not to make a profit.” Even if you earn occasional income from doing such an activity, the primary purpose must be something other than making a profit.
To distinguish between a hobby and a business, you must take into account all the facts and circumstances of your situation. The IRS lays out the following 9 factors that should be considered when establishing if an activity is a business engaged in making a profit:
- Whether you carry on the activity in a businesslike manner
- Whether the time and effort you put into the activity indicate that you intend to make it profitable
- Whether you depend on income from the activity for your livelihood
- Whether your losses are due to circumstances beyond your control, or are normal in the startup phase of your type of business
- Whether you adjust your methods of operation in an attempt to improve profitability
- Whether you (or your advisors) have the knowledge needed to carry on the activity as a successful business
- Whether you were successful in making a profit in similar activities in the past
- Whether the activity makes a profit in some years, and how much profit it makes
- Whether you can expect to make a future profit from the appreciation of the assets used in the activity
According to the IRS, an activity is deemed as a business if it makes a profit during at least 3 of the last 5 tax years, including the current year
from tax tips on line:
Tax Deductible Expenses for Artists
Artists: Use this list to help organize your art tax preparation.
This is a basic list of typical expenses incurred by artists. You may have others.
- Art supplies
- Books, magazines, reference material
- Business gifts
- Business insurance
- Business meals and entertainment
- Cabs, subways, buses
- Copying, printing
- Cultural events/ museum entrance fees
- Entry fees
- Equipment and software
- Film & processing
- Gallery fees
- Gas and electric
- Legal fees
- Memberships (museums, professional organizations)
- Messengers, private mail carriers, postage
- Office supplies
- Studio or home office rent
- Tax preparation,
Hobby Loss: Can Artists Take Losses on Their Tax Returns?
“I’m an artist. Before the economic crisis, I was able to make a living selling my paintings but I’ve lost money trying to sell my paintings for the past three years. Can I deduct those losses?”
The IRS says that you can deduct your losses if you are engaged in your business to make a profit. One way for the IRS to determine if you’re serious about making a profit is that you have made a profit in three out of the past five years. This does not mean that you can take losses for two out of five years without running into what is called the “hobby loss” issue. This is a popular misconception that is unfortunately relied on incorrectly. When the hobby loss issue is raised, it means the IRS is challenging the person’s right to take losses and saying that their endeavor is a hobby. The hobby loss issue tends to make artists and writers quite upset. Understandably, many of these people feel that the very endeavor of their life is being questioned.
I believe that often it is the people who are feeling threatened that are the ones who can successfully defend their right to take losses when they are challenged by the IRS. My experience is that most of the artists I encounter are serious about making a profit as artists. If you are serious about making a profit as well as making your art, then this article is written for you
There are a variety of people who might not be good candidates for taking losses. These include the technology executive who decides he’s always wanted to be a writer and who now wants to write and self-publish a book on worldwide travel that includes a lot of travel expenses; the person who paints on the weekends and has no interest in trying to sell his work; or the guy who does woodworking and pays for a workshop and a lot of equipment and supplies but who doesn’t sell what he does.
The IRS has 9 factors which they use to determine if your losses should be subject to hobby loss rules. Each case is determined on a combination of these factors.
- The manner in which the taxpayer carried on the activity. For instance, let’s take as an example a photographer who sells to magazines, who has exhibitions in galleries, and who has published books. She will have a record of her invoices and the checks or payments she has received along with any correspondence she has for each job. She has a website as well as a Facebook page and other social media that show her work. She has a resume that is kept up to date as well as stationery and business cards that reflect her identity as a photographer. She keeps records of every dollar she earns and every dollar she spends as well as every receipt for these expenses. She’s recording her billing, her income and her expenses on Excel but is at the point of hiring a bookkeeper to do it in Quickbooks. In my opinion, she is carrying herself in a businesslike manner.
- The expertise of the taxpayer or his or her advisers. This means, for example, that if you have a Masters of Fine Art in writing you could well be considered to have expertise or at least background as a writer. Belonging to professional associations and taking ongoing workshops in conducting your business as an artist and in various aspects of an artist’s life shows keeping up in one’s field. Winning grants and awards shows your expertise in your area. If you are an artist, selling your work to museums among others and having shows in reputable galleries would in my experience help satisfy the requirement for expertise as an artist. Using professionals like attorneys and tax preparers who specialize in the arts shows the expertise of the people you hire.
- The time and effort of the taxpayer in carrying on the activity. The expectation of the IRS is that the time and effort spent on the activity should be significant. Clearly someone who is working full time doing something else cannot put in the same amount of time as someone who is a full time artist. Suffice it to say, that if you are consistently working to both create your work and market your work, it will reflect in the amount of time you have spent. If you’re not passionate about what you’re doing, my experience is that you will stop doing it and that this is an issue that will not be relevant to you after a few years because you will have stopped making your art or writing your novels.
- The expectation that the assets used may appreciate in value. I call this the “Van Gogh effect”. It’s the idea that long after something is created, it might be worth a lot more than it is presently. I suspect it is also why a business as an editor cannot take prolonged losses whereas one as an artist may be able to: a service done one year typically does not increase in value as do various artworks over the years. While an artist can’t count on future price appreciation, an increase in prices of your work in the past might show that an expectation of future price appreciation is appropriate.
- The success of the taxpayer in carrying on other similar or dissimilar activities. An example where this came into play was with the taxpayer who went in and out of different businesses every few years; the taxpayer’s spouse financed the losses, and the agent didn’t believe that the taxpayer was serious about the business in the year being audited and the lack of success.
- The taxpayer’s history of income or loss with respect to the activity. Expect your tax returns for as long as you’ve been involved in your business to be reviewed. A business with years of significant profit and some years of losses will be regarded in a more favorable light than one with enormous losses and an occasional tiny gain.
- The amount of occasional profits, if any, which are earned. In my opinion,it is better to show a history of profits, however small, than one of losses, however small. Thus you might consider putting off some year-end purchases if it means showing a profit. Why? In case you get audited this profit could well help you.
- The financial status of the taxpayer. If you are struggling with three part time jobs so that you can keep on making art, it may show your seriousness as an artist rather than if your spouse is the owner of a social media company and you keep an art studio that you only use when you come to that house in the winter. In this second case, you might have a much harder time showing that you’re seriously trying to make a profit.
- Elements of personal pleasure or recreation. I’ve never understood how this one can be decided and in my experience isn’t a major consideration. At face value, it seems that you might not be able to take a loss if the agent thinks you enjoyed making your sculpture. I’ve not seen this issue come up as a major issue during an audit. I had a colleague have it discussed at an audit for a travel writer who at first had his expenses disallowed for camping out for an article about traveling in national parks; I believe the issue was dropped.
This article is only addressing one aspect of expenses and that is the hobby loss issue. It is not addressing whether the expenses themselves are legitimate and whether they are ordinary and necessary. If the expenses cannot be proven and/or if they are not ordinary and necessary, they simply will not be allowed.
My belief and experience is that if someone is serious about making and selling their work and if they carry themselves professionally and do what successful people in their field do to promote their work, given the proper advice, they could well prevail if challenged about their taking legitimate losses.
How to Deduct Hobby Expenses
In order to deduct your hobby expenses, you must itemize deductions on your income tax return. There are 3 categories of deductions that your hobby expenses may fall into, and these deductions must be taken in the following order:
- Category 1: Deductions you can take for personal as well as business activities are allowed in full. For individuals, all non-business deductions (such as those for home mortgage interest, taxes, and casualty losses) belong in this category.
- Category 2: Deductions that don’t result in an adjustment to the basis of property are allowed next, but only to the extent that your gross income from the activity exceeds your deductions under the first category.
- Category 3: Business deductions that decrease the basis of property are allowed last, but only to the extent that your gross income from the activity exceeds your deductions from the first 2 categories.
As a business: Use Schedule A (Form 1040) to claim your itemized deductions. Any amounts from categories 2 and 3 are considered miscellaneous deductions and are subject to the % AGI (adjusted gross income) limit.