There may be a documentary film to be made about the documentary
filmmaker who stood up to the IRS and won! A recent tax court case
could be an extremely important precedent for independent
filmmakers and documentarians. The issue in the case was the
ability of the filmmaker to take deductions for expenses incurred
in creating a documentary film given the fact that many documentary
films do not make a profit.
The IRS has two different tax regimes. One for people who are, for
lack of a better word, deemed "professionals," and the
other for "hobbyists." Deductions are permitted for
professionals: "those who engage in an activity for
profit." The "professional" may deduct ordinary and
necessary business expenses incurred in carrying on a trade or
business. The tricky part for documentarians or independent
filmmakers is satisfying the IRS that their filmmaking is in fact
engaging in a trade or business and not a hobby. In order to do
that, the filmmaker must show the IRS that she or he had a bona
fide intent to make a profit. The burden for that is on the
taxpayer. Whether one is considered to be "engaged in an
activity for profit" is handled on a case by case basis,
taking into account the facts and circumstances of each separate
situation, and the factors provided in IRS Section 183. Since
documentarians often do not make a profit, the IRS has taken the
position that documentary filmmaking is not an activity engaged in
for profit, but rather a "hobby." The IRS does this even
though the legal requirement is not that the filmmaker actually
make a profit, but rather that it was her or his expectation and
bona fide intent (even if not a reasonable expectation) to make a
profit.
In the recent case of Lee Story and William Story v.
Commissioner of Internal Revenue, (T.C. memo 2012-15 April 19,
2012), we find a filmmaker who, as many independent film makers and
documentarians, has a 9-to-5 job. In this case she was an attorney,
and made a film called Smile 'Till it Hurts, which was
about the "Up With People" story. In the Tax Court
opinion (which is laid out with a bit of tongue in cheek, as the
sections of the opinion are entitled Prequel, Light,
Camera...Action, Publicity, Applause, Credit, the Fine Box Office
Arrangements, Tracking the Numbers and Sequel), the court ruled
that even though a profit was not made on this film, and even
though the taxpayer had another job as her principal occupation,
when viewing the nine factors set out in the regulations, she was
still entitled to take appropriate deductions.
The reason this case is so important to independent creators is
that if they are deemed to be a "trade or business"
(engaged in an activity for profit), and they have expenses that
exceed the revenues from the activity (in this case the creation of
the film), they can deduct them against other income. If they are
not considered to be in "trade or business," but rather a
"hobbyist," then they can only take the deductions
against the income generated from the activity. So in the case of a
documentary where there is no theatrical release, or the revenue
from festivals are nominal, then the percentage of the cost of
making the film that the filmmaker can actually deduct is usually
going to be relatively slight. If, however, the filmmaker is
in "trade or business" and has a 9-to-5 job or
investments to support the filmmaking, then he or she can deduct
the losses incurred in making the film against other non-film
related income (there are, of course, procedures to be followed and
limits). There are scores of fascinating cases in this area of law,
where the IRS challenged writers, filmmakers, musicians, artists,
etc. (all who struggle to make a profit yet who truly consider
themselves to be profit oriented professionals) as to whether the
artistic endeavors were in fact a bona fide trade or business, and
their ability to take full deductions.
What is important to note is how the court analyzed the nine
factors. The key take away from the analysis, and one of the
reasons that the taxpayer in this case won, and is true throughout
all of these types of cases, is the professionalism in which the
taxpayer undertook her activities. In this case, she had a separate
bank accounts, separate credit cards (in other words, no comingling
of funds), spent a great deal of time on the project, engaged the
appropriate experts and consultants, tried to commercially exploit
the film, went to all the appropriate type of conferences,
festivals, conferences and the like. She made every reasonable
effort to try and make money on the project.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.