A version of this post was originally published by Bloomberg Finance L.P. in the Daily Tax Report. Reprinted with permission
A recent Tax Court decision provides useful guidance to documentary filmmakers about whether their filmmaking is a trade or business. In Storey v. Commissioner of Internal Revenue (decided April 19, 2012) a documentary filmmaker, who produced a documentary about the 1960's singing group "Up With People," prevailed over a deficiency assessment by the IRS for 2006, 2007 and 2008 in an aggregate amount of $260,000, plus penalties. The IRS had initially rejected the filmmaker's attempt to deduct her production expenses under Section 181 of the Internal Revenue Code ("IRC").
In order to be able to deduct the costs of development and production from other earned income, the filmmaking has to be a trade or business. Being able to meet this test is important since many documentary filmmakers have to earn a living during the period when they are working on their films, by taking on other work to support themselves.
In this case, the filmmaker had a full-time job as an attorney, billing 30-35 hours a week during the entire six year production process. The Commissioner argued that because she was a partner in a law firm, which meant that "she had a full-time job with significant responsibility," her filmmaking activity could not qualify as a trade or business. If the Commissioner were correct, it would mean that the filmmaking expenses would not be deductible as ordinary expenses incurred in a trade or business, and so not deductible against Ms. Storey's income as an attorney. If her documentary filmmaking were not a trade or business, she could only deduct her filmmaking losses against revenue from the film under Sec. 183 (IRC).
Citing a number of cases, the Court found that "a taxpayer may engage in more than one trade or business at any one time." The Court then noted that there are two key elements in determining whether or not a taxpayer is engaged in a trade or business when making a documentary film:
1.1 The activity of making the movie must be continuous and regular; and
1.2 The taxpayer's primary purpose for engaging in the activity must be for income or profit.
The Court found plenty of effort over the 6 year production process to easily take care of the "continuous and regular" element.
In considering the second element, the Court then pointed to nine non-exclusive factors to consider when determining whether an activity was primarily to generate income or profit: (1) the manner in which the taxpayer engaged in the activity; (2) the taxpayer's expertise in the activity; (3) time and efforts spent; (4) expectation that assets in the activity may appreciate in value; (5) success in similar activity; (6) history of income or losses from activity; (7) amount of occasional profits; (8) financial status of the taxpayer; and (9) whether elements of personal pleasure or recreation are involved.
Ms. Storey had treated her filmmaking "in a businesslike manner," which included having a business plan which she presented to possible investors; making changes to the plan as she got feedback from screenings in an effort to increase the chances of making a profit; maintaining complete and accurate books and records, including hiring a bookkeeper to assist her; and advertising the film and hiring a publicist for the film.
She took a community college one month course, had read extensively, had participated in training events such as a Sundance producers' conference, and had sought guidance from and hired industry professionals to assist her.
Ms. Storey spent nights and weekends working on the film, and had the flexibility to arrange her legal work so that she could spend time working on the film as required during the week.
Since the film was the only asset in her documentary activity, the expectation about an increase in value of the assets was closely tied to her expectation of making a profit, and her marketing activity and submission to film festivals supported both expectations as reasonable.
Although "Up With People" was Ms. Storey's first film, she was successful in other activities including her legal practice and the fact that she had directed and produced a number of amateur musical productions for a five or six year period.
On the issues of a history of profits and losses, and occasional profits, the Court noted that particularly in the arts, there can be a lengthy development or startup period, and so decided not to give too much weight to these two factors.
On the last issue, whether the activity was pleasurable or involved elements of recreation, Ms. Storey admitted that she enjoyed the work and got personal satisfaction from learning more about her husband's history. However the Court found that personal enjoyment did not negate the other factors leading to a conclusion that the filmmaking was engaged in as a trade or business.
The Court's detailed analysis of the nine factors which determine if an activity is a trade or business gives guidance to documentary filmmakers who wish to deduct filmmaking losses from other income: there should be a business plan which can be presented to potential investors (and in a tax audit), updated based on events as they unfold; the filmmaker must be able to show a level of expertise, from education, experience with professionals, and hiring other professionals to help make the film; efforts to market the film including festival submissions (and hopefully awards) and obtaining reviews which are hopefully positive, and even hiring a publicist.
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