Hobby Loss Rule
One of the biggest challenges of show business is the fact that no matter how hard an actor or artist might work to earn a living, their expenses often exceed the income they make from their craft. Despite all the auditions, classes, interviews, and hard work, it is not uncommon for an artist to go for months or even years without a profit. Because of this harsh reality, all artists should be aware of Internal Revenue Code Section 183, also known as "The Hobby Loss Rule."
If an activity is presumed to be for profit, then you can write off all of your business expenses regardless if the net result is a loss. If an activity is considered a hobby, then you cannot write off your expenses as business deductions. Instead you must take them as itemized deductions, and you can only deduct the expenses to the extent of your income from the activity for that tax year. The Hobby Loss Rule states that an activity is presumed to be for profit if you make a profit for at least 3 out of 5 tax years.
Now the good news for artists is that even if you don't meet the 3 year rule stated above, you can still continue to deduct your expenses as business expenses. In 2013, a New York artist named Susan Crile challenged an IRS decision that categorized her painting and printmaking profession as a hobby. The IRS claimed that since she recorded a yearly average income of about $16,000 from 1971-2013, and wrote off all of her art expenses, she had underpaid her taxes by $81,000 during that time period. The tax court disagreed with the IRS decision, and stated that Crile had "met her burden of proving that in carrying on her activity as an artist, she had an actual and honest objective of making a profit.” The moral of this story is that if you want to deduct your expenses, you have to be able to show that you are actively engaged in pursuing income and not treating the activity as a hobby.
If you get audited by the IRS and you don't meet up to the 3 year rule, you have to show that you did everything that you could to make a profit and that you approached your craft as a business. This is where keeping good records comes into play. Are you a member of a union? Do you have an agent? Have you been submitted for roles? How often do you go to auditions? Have you been taking classes to improve your craft? You might not have control over getting hired for a job, but you do have control over what you do to get hired. If you have sufficient records to verify your efforts, your chances of being able to keep your business deductions will be much greater. See Record Keeping for tips on how to keep good records.