Ralph Sevush: I’m going to introduce Tom Garvin now. Tom is an attorney from Los Angeles, Beverly Hills. He’s driven down through the rain to be with us today and I appreciate that very much. Tom, could you talk to us a little bit about the big picture here, the architecture. Could you describe what that is and how that works?
Thomas Garvin: I will, but first I have great respect and high regard for the written word and for authors and playwrights. So don’t take any of these comments as anything other than just, unfortunately, I happen to be the person on the panel who’s the lawyer. (everyone laughs). It’s a very good question. It goes the other way around which is, we have a voluntary compliance system, and so the cornerstone of the tax system is that everybody self-assesses, reports the amount of their gross income, and the taxpayer has the individual burden of proof to establish their deductions. It doesn’t matter whether it’s a mortgage deduction, medical, or anything else.
Everybody has something that they like, an avocation, a pleasure, a pursuit, something that they find enjoyable. People that have a passion for horses, cars, or wealthy people that like having their own jet aircraft. The tax law says it’s the burden of the taxpayer to establish that if you’re going to claim an expense or deduction, that the deduction is permitted under the tax code. So one of the things that they don’t permit under the tax code is deductions for what are, sometimes in shorthand referred to as “hobby loss” deductions.
So if you’re going to take a deduction, you have to then say, here is what the activity was that I was engaged in, it was a business undertaking, a commercial undertaking, and then establish how it is that you have the primary purpose of generating a profit, and then establish your entitlement to all the deductions. The tax authorities have heard every possible thing from the people that like horses or they like private jet aircraft, or they like collecting cars, or they paint and they give their paintings away. If you’re someone who has as your job the auditing and the selection of returns and asking questions, you know, human beings are human beings. I’m sure you’re all absolutely wonderful and would be the best people in the world to get to know. But the statistical odds of 1,000 people coming together in a room and 1,000 people all being 100% scrupulously honest and scrupulous in self-filing is unlikely. The system of taxation that we have in this country relies on self-assessment, and the tool by which they try to deal with compliance, as it’s often referred to, is random audits or something that triggers an audit, and it does result in the types of experience taxpayers have when they’re audited.
As a result, there’s this dividing line between, on one hand, establishing that you’re doing something for a business pecuniary profit motive and establishing what the scope of that is, and on the other hand, what is it that are the deductions attributable that you then are claiming as expenses are legitimate permissible deductions. There is a short one-page handout that gives you a sense of what the factors are that go into determining whether the activity is a trade or business carried on for a profit.
Ralph Sevush: And so then last year you had this woman, Crile, who is an art teacher at Hunter College who was, like Gary and Michèle, selected by the IRS for an audit. She had her own career as a painter and those expenses were disallowed. There was a legal proceeding and she won and, Tom are you familiar with that case, do you know the facts at all?
Thomas Garvin: I became familiar with the case when I was asked by you recently to participate in this program.
Ralph Sevush: Why do you think it turned out the way it did then?
Thomas Garvin: I’ve gone through it and looked at it. For those of you who have a passing desire, it’s a well-written, 53-page court decision. Crile spent 40 years as an artist in every possible medium—oil, printmaking, woodcut, pastels, etc. She is a full-time tenured professor at Hunter College, with numerous international accolades, residencies, fellowships, serving on an advisory panel for the National Endowment for the Arts. She was teaching full-time, and also working 30 hours a week on her business. Her work is in 25 museums, the Metropolitan Museum of Art, The Guggenheim, The Hirshhorn. So they audited someone whose artwork has been acquired and hangs in the U.S. government’s own Federal Reserve room. (everyone laughs) Her art is also in the Library of Congress and The State Department. It’s been acquired by AT&T, Exxon, Bank of America, Chase, General Mills. Her first review in The New York Times was in 1971, she’s received awards from the NEA, she’s been represented constantly by galleries in New York. You may have seen some of her work. She actually traveled during the first Gulf War and dealt with images of firefighters in the oilfields of Kuwait. She did the series on Abu Ghraib prison during the Iraq war.
To maintain books and records, she used to keep a card catalog of all of her expenses and artwork, including photographs and copies of all the work through all the years of her career. This case was argued in the United States Tax Court and resulted in the published decision in October of last year.
But the bottom line is, I don’t think that just from a summary review of her longevity, career, and track record that anyone would say that the lady is not an artist. Nonetheless, it didn’t resolve itself and resulted in a full legal proceeding with lawyers on each side. She was represented by a large New York law firm. This was fully briefed and argued. She had expert witnesses from the head of the Yale University School of Art, other experts explaining to the Tax Court that, yes, this actually is a preeminent artist. She had a clear keeping of her work as an artist for which she exhibited, sold, marketed. She maintained a database of over 2,000 people whom she contacted regularly for buying her artwork. She kept track of things. She regularly earned income from her teaching and was claiming deductions for the separate business costs of her artwork business.
Ralph Sevush: One has to wonder why the IRS pursued it as far as they did given those facts?
Tom Garvin: Well, I would assume that this lady was determined that she was correct and she decided that she wasn’t going to resolve it. Or the person dealing with it from the government wasn’t going to resolve it on terms that were equal to zero or walk away, so it went through the whole full litigation process and resulted in the decision. The tax courts agreed that she had established a profit intention for her art business.
Ralph Sevush: I’d like to bring Robert into this. Robert Oberstein is an accountant and partner at R.S. Oak (RSO). You’re based in San Diego.
Robert Oberstein: No, I’m in LA in the valley.
Ralph Sevush: Okay, so you took a schlep down here, too.
Robert Oberstein: I did, it was delightful. (every- one laughs)
Ralph Sevush: You represent a number of artists, I think, and writers who have been audited?
Robert Oberstein: I do. Well, not that had been audited because the idea is not to be audited.
Ralph Sevush: Right, right. How did you keep them from getting audited?
Robert Oberstein: I don’t know if you can keep them from getting audited. One thought is that, the lady never had her work put up at the IRS, that was the problem. (everyone laughs) Part of working with the IRS is dealing with the structure of a tax return. That’s probably important. I wonder, when they hit you for this audit, did you, without divulging any- thing of course, did you use a Schedule C to claim your expenses as a business expense?
Michèle Rittenhouse: Oh yes. I did.
Robert Oberstein: I’m wondering if because you said part of it was from teaching and whether it was perhaps an employee business expense versus a Schedule C?
Michèle Rittenhouse: There were Schedule C and an employee business expense in there.
Robert Oberstein: Okay, because a lot of what the IRS does when they look at tax returns is evaluated the weight of whether it’s “above the line” or “below the line.” Sometimes you get away with it, sometimes it looks messy. Sometimes it looks, to them, in the wrong spot. So, some- times something triggers an audit, and sometimes it’s just random. I don’t know if it’s much that way anymore in that they identified certain industries to audit. The entertainment industry was hit for a very long period of time. They were getting audits and audits and audits and they seemed to have shied away from that somewhat. So the structure is important. It’s fascinating when clients go to an audit because there’s an element of emotion involved when the taxpayer confronts the auditor, and often times it’s the intermediary. And I know it’s expensive and you view it as a waste of money, but some- times, if it’s a high profile kind of audit, maybe it’s good to have an intermediary because dealing with the auditor itself is somewhat a finesse factor. Some of them, of course, are not real nice, so it’s difficult at times.
Ralph Sevush: If you’re not making money at this business, how does that factor into the audit process, the trigger for an audit? When you’re taking deductions against no revenues?
Robert Oberstein: Well it’s sort of like, if you aren’t making money, are you treating it like a business? And I think it’s the IRS, not necessarily in the artistic mode of life, wanting to see whether it’s a business-like kind of venture. Do you have the separate checkbook? Have you isolated all your expenses? Have you documented everything? Do you have records? Not just checks but receipts and so forth, and are you treating it like a business? That’s probably the key. Part of it is convincing the auditor that it is appropriate, this is what I do. Maybe it’s in the wrong slot and that’s what triggered the audit, perhaps. Or is it ordinary for your business? If it’s “ordinary,” then it’s done consistently over the years, and, if it’s done consistently over the years, do you have losses and losses and losses, and so perhaps they look at this and say, how do you survive? Well, if you have other sources of income maybe that’s how you survive and maybe that’s how they look at it and they say well this is not really a business, this is a hobby. So maybe it’s taking these kinds of expenses and incorporating it into your profit-making mode.
Gary Garrison: It’s so interesting that you would say that, Robert, because before my 2012 audit, the one where I ended up paying the penalty, I never had a separate credit card for my business expenses. I never had a separate checking account. You know, I would just be out using my American Express card. It’s all separate now because that was the one thing my accountant came back and said to do.
Ralph Sevush: Bob has given you in the handouts a checklist of hobby-loss rules and also what you need to keep track of and how to do it. But are there any of those that you want to highlight or point to, that are sort of glaringly important?
Robert Oberstein: The third page, number nine. It relates to whether you expect to make future profit from the appreciation of assets. And what I meant by that was that if you have losses and losses and losses but in the future there may be income generated from the sale of these assets because it has appreciated in value, well maybe that’s the indication that you do have a business. You do have a profit motive. So part of it is the motive aspect of it.
Ralph Sevush: How do they distinguish between having an unsuccessful business and having a hobby? I mean, if they’re trying to get into your subjective intent of why you’re doing this, if you’re getting loss after loss after loss, year after year, can’t it simply be an unsuccessful business, instead of just a hobby?
I’d like to open up the discussion to questions from the audience.
Audience Member 1: So I’m in a similar situation to you, I think, Michèle. I work full-time at a university and a lot of my work ends up being developed as part of my work there. They don’t pay me separately to make a play, but then the play goes there. So my actual income from playwriting is very minimal, but I’m still submitting work and I’m a professional playwright outside, but it may be two or three years before I get income as a playwright that is separate from my teaching. I’m just curious: you said something about the difference between a teaching expense or an unreimbursed business expense. Where’s the smartest place for me to put that? Because right now, I would fall under the term of the hobby-loss, which is so demeaning, but that’s what I would be and yet my work is being produced regularly.
Thomas Garvin: I wouldn’t say you necessarily fall under the term hobby-loss simply solely because you haven’t made any economic profit thus far.
Audience Member 1: Well I have, just not for a couple of years.
Thomas Garvin: This lady that I mentioned in the Crile case, the judges determined that of the factors that were gone through, the IRS was the winner on that factor. None of these individual factors are controlling. It’s the same list that we both have in the outlines. They look at each one taking all the facts and circumstances. If you can establish all or a majority of the factors and you legitimately run it and operate a clear separate business then you can have some years with no income.
Audience Member 2: Say I make a minimal income as a playwright but I’m also a teacher.
Thomas Garvin: That’s your day job.
Audience Member 2: That’s my day job, yeah, and so this really hasn’t come up for me since I make such a little amount as a playwright, but I do make some and my accountant has deductions based on the fact that I have income, so where do I stand in this?
Thomas Garvin: I defer to Robert.
Robert Oberstein: Going back to the structure of a return, what are the expenses attributable to, if they’re only attributable to writing a play or they’re attributable to teaching. It’s an interesting delineation: does it help me in my job as a teacher? Prob- ably. Or is it a separate venture that you’re trying to accomplish? If it’s a separate venture and you’re intent is to sell something then I think taking it as a deduction as that tiny expense is probably a good idea. But you have to, again, establish that you’re going to try to sell something.
Ralph Sevush: Yes, in the Crile case they made an interesting distinction and said that, as a teacher, she had an obligation to exhibit the work but she had to show an effort to sell her work, not just exhibit it. Her job didn’t require her to sell them, but it did require her to exhibit them. So, again, that points to treating your playwriting as a profession. Get out of the circle of hobbyism.
We’re out of time now, and I want to thank everybody, Tom and Michèle, Robert and Gary. Thank you all.