Originally published on Forbes.com. Oct 6th, 2014
Susan Crile is a distinguished artist. Some of her work is owned by the Metropolitan Museum of Art. That might not make much of an impression on a revenue agent. To get the revenue agent job you need a college degree with at least 30 credit hours in accounting, no art courses required.
Although, it may not end up helping her that much at least she found a Tax Court judge who had some appreciation for her artistic work. Here is the story.
The Issue
What will make an impression on a revenue agent is year after year of Schedule C losses on a return with steady W-2 income. In the years under audit (2004 – 2008) Professor Crile’s salary as a tenured professor in studio arts at Hunter College went from $85,999 to $106,058. Roughly $100,000 in salary and $40,000 to $60,000 losses on Schedule C, year in and year out brings up the issue of Section 183 – Activities not engaged in for profit. Section 183 is sometimes referred to as the “hobby loss” rule which, in the case of Professor Crile, is really insulting.
In his discussion of “taxpayer’s success in other activities”, Judge Albert Lauber notes that here we have an inversion of the typical “hobby loss” case.
In a typical section 183 case, the taxpayer achieves considerable success in a business activity and later embarks on a new activity that the IRS regards as a hobby or sport. Here the sequence is reversed. Petitioner embarked on the challenged activity (as an artist) a decade before she secured her salaried position (as a professor). And she practiced as an artist for 25 years before becoming a full professor in 1996. Petitioner has plainly been successful in her academic career. She rose through the ranks at Hunter College from visiting assistant professor to tenured member of the faculty. Obtaining a studio art teaching position at Hunter College is extremely competitive, and her steady upward path shows that she had the skills, determination, and personal qualities that might also benefit her career as an artist. Because she commenced her career as an artist many years before she started teaching, her success in the latter is not exactly a “leading indicator” of success in the former. But the academic success and prestige she gained in the late 1990s may have contributed to her belief that her prospects as an artist could flourish during the next decade.
Susan Crile Definitely Not A Hobbyist
It struck me that the IRS was pretty off-base with the hobby loss aspect of this case and I got a good sense from the outset that Judge Lauber was heading in that direction. He devotes ten paragraphs to Professor Crile’s distinction as an artist before getting down to business, so to speak, beginning with:
She has worked for more than 40 years in media that include oil, acrylic, charcoal, pas-tels, printmaking, lithograph, woodcut, and silkscreen. She has exhibited and sold her art through leading galleries; she has received numerous professional acco-lades, residencies, and fellowships; and she is a full-time tenured professor of studio art at Hunter College in New York City.
And proceeding to:
Petitioner’s artwork hangs in the permanent collections of at least 25 museums. These include the Metropolitan Museum of Art, the Guggenheim Museum, the Brooklyn Museum of Art, the Phillips Collection, the Hirshhorn Museum, and art museums at eight colleges and universities. Museums have a rigorous vetting process for acquiring art. Museum acquisitions boost an artist’s reputation in the eyes of collectors and may contribute to price increases for the artist’s other works.
Lew Taishoff, who was taking a pass on this case till I asked him about it, wrote:
So much of the opinion deals with Susan’s illustrious career and accomplishments, that I thought it better suited to the introduction to a catalogue raisonnée than to a blogpost on taxes.
The Education Of A Tax Court Judge
Lew’s comment is probably a good segue into another thing that struck me about this case. Note the phrase catalogue raisonnée, which I had to look up. It’s part of Lew’s active vocabulary. Bottom line is that, in general, lawyers have much better educations than accountants. That had me wondering if Judge Lauber’s appreciation for art would show up in his biography. Well, it did. Between his bachelor’s degree from Yale in 1971 and his JD from Yale in 1977, he received an MA in classics from Clare College, Cambridge. That’s not the Cambridge that is forty miles or so east of Worcester with the former seminary for Congregational ministers and the technical college, the town where Margaret Fuller and Thomas Wentworth Higginson grew up. It’s the one in England. Clare College was founded in 1326.
What Is Different About This Case?
There are traditionally nine factors that are considered in a Section 183 case.
1. Manner in Which Activity is Conducted
2. Expertise of Taxpayers and Advisors
3. Taxpayers Time and Effort
4. Expectation of Appreciation in Value
5. Taxpayers Success in Other Activities
6. History of Income and Loss
7. Amount of Occasional Profits
8. Taxpayer’s Financial Status
9. Elements of Personal Pleasure
Judge Lauber was willing to admit that IRS wins on 6 and 7, but the rest all favor the taxpayer or were neutral. So she won, at least on the 183 issue.
What I noted as being different from other cases is that Judge Lauber did not harp on the lack of a written business plan.
Although petitioner did not have a written business plan, she had a business plan and she pursued it consistently. Petitioner understood the general factors that affect the pricing of art —a history of sales, gallery representation, solo exhibits, positive critical reviews, and prestigious awards, fellowships, and residences. She then worked to enhance her credentials and professional stature in each of these respects, in an effort to increase the value of her art.
The other thing you will often see when taxpayers lose is that they only consulted with people who understood the field not how to make money in the field.
Like most artists, petitioner did not retain professional ]business consultants. Rather, her principal “advisors” were the galleries that represented her. Through-out her career, petitioner was represented by five New York art galleries. These galleries exhibited her work; arranged openings and customer receptions; and marketed her work to collectors. The expertise of petitioner’s advisors seems indisputable.
While conceding that petitioner and her advisors have the requisite artistic expertise, respondent contends that she lacks expertise in the economics of being an artist. But petitioner does not need an economics degree to know how to sell art.
All in all, I think the decision recognizes that there can be a profit motive in the face of persistent losses particularly in fields like art, that have a significant element of crapshoot to them. There is a good chance that Professor Crile’s inventory might be worth quite a bit at some point.
Is Professor Crile Out Of The Woods?
Not hardly and this brings up another thing that is very unusual about the case. Someone with persistent Schedule C losses usually has two other problems with the IRS besides Code Section 183. They both concern Code Section 162, Trade or Business Expense. The two issues are whether the expenses are substantiated and whether they are “ordinary and necessary” business expenses. Judge Lauber decided to bifurcate the case between the Section 183 issue and the Section 162 issues. This ruling was only on the “hobby loss”. So whatever losses Professor Crile has from her art business are deductible, but how much of the quarter-million or so in losses over five years will be deemed good business deductions remains to be ruled on. So Professor Crile may be waiting for the other shoe to drop. There is a strong hint that when it does she will not like the sound of it:
Petitioner’s theory for claiming deductions seems to have been that most experiences an artist has may contribute to her art and that most people with
whom an artist socializes may become customers or otherwise advance her career. The trial established that a significant number of the deductions she claimed were not, within the meaning of section 162(a), “ordinary and necessary expenses” of conducting her art business but were “personal, living, or family expenses” non- deductible under section 262(a). The latter expenses appear to have included telephone and cable television bills, newspaper and magazine subscriptions, gratuities to doormen in her apartment building, taxicabs to the opera, museums, and social events, restaurant meals with friends and acquaintances, and international travel to gain inspiration from paintings in European museums. We have deferred to another day the calibration of petitioner’s deductible business expenses. But it was clear to the Court that the economic losses she actually sustained in her art business were substantially smaller than the tax losses reported on her Schedules C, owing to the inclusion of many personal expenses when calculating her business income.
I did like Judge Lauber splitting the decision into two pieces because the IRS really deserves a big loss for attacking this case on Section 183 grounds. That may be the point he is trying to make since it might well turn out the much of the deficiency will be upheld. So this taxpayer win may turn out to be a Pyrrhic victory.
The Other Lesson
The other lesson in the case is that it is tough to make a living as an artist. Among the slings and arrows, Professor Crile experienced was this one noted in the footnotes:
For example, petitioner had a solo exhibition of ten abstract paintings at Michael Steinberg Fine Art in 2009. Each painting was priced at $1,800 and all ten were sold. Petitioner never received payment for these works when the gallery closed during the financial crisis.
Just like the horse business, one GD thing after another.
Update
I just noticed that Tony Nitti also covered this case. Actually I have to thank Joe Kristan for that. Tony seems to share my sentiment that the IRS was way off base in attacking this case under Section 183. He gives a more thorough rundown of the nine factors. He also notes the difficulty of making a living as an artist. His opening line is:
It has to suck to make your living as an artist.
I’m going to nominate that as most eloquent tax blogging sentence of the month.