New Case Spotlights 'Hobby Losses' of Filmmaker

By Ken Berry
 
The filmmaker who produced and directed the documentary Smile 'Til It Hurts: The Up with People Story, has emerged from a protracted battle with the IRS with a giant smile on her face.
 
In a closely watched new decision, the Tax Court says that Lee Storey, who was earning substantial income as an attorney while she shepherded the film to theaters, is entitled to write off hundreds of thousands of tax losses.
 
The IRS challenged the deductions for production expenses on the grounds that Storey's filmmaking was a mere hobby. It had rejected her claims and assessed back taxes and penalties totaling more than $259,000. But Storey was able to demonstrate to the court that she engaged in the filmmaking project to earn a profit. 
 
Talking Points
The nine factors traditionally used to distinguish a business from a hobby are:
  • The manner in which the taxpayer carries on the activity.
  • The expertise of the taxpayer or his or her advisors.
  • The time and effort expended by the taxpayer in carrying on the activity.
  • The expectations that assets used in the activity may appreciate in value.
  • The success of the taxpayer in carrying on other similar or dissimilar activities.
  • The taxpayer's history of income or losses with respect to the activity.
  • The amount of occasional profits, if any, which are earned.
  • The financial status of the taxpayer.
  • Any elements of personal pleasure or recreation.
"I need to go celebrate. I need to pinch myself," said Storey. "The documentary film community is going to be thrilled. That's a huge issue for them."
 
Initially, it appeared that Judge Diane L. Kroupa was poised to rule against Storey. "By its very nature, a documentary to me means that it's not for profit. You're doing it to educate. You're doing it to expose," said Krupa during a hearing. But the judge was swayed by several factors demonstrating that Storey treated the activity as a business, including that she:
 
  • Kept detailed business records,
  • Wrote and modified a business plan,
  • Solicited outside financing,
  • Hired a bookkeeper,
  • Obtained liability insurance, and
  • Sought feedback from industry pros.
The IRS and taxpayers often butt heads over losses resulting from activities that may be considered to be pleasurable or recreational. Losses from a hobby are deductible only up to the amount of hobby income. Traditionally, the courts will use nine criteria to determine if the activity measures up as a business. 
 
Smile 'Til It Hurts is Storey's first documentary. It won several awards after viewings at prestigious film festivals like Sundance and Tribeca. Despite its critical success, however, the documentary hasn't proven to be a moneymaker. Storey is currently working on a project about Peter Asher, the legendary music producer. 
 
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