Documentary Filmmaker Gets IRS To “Smile ‘Til It Hurts”
by Jerry Glover
April 26, 2012
For the first time, to our knowledge, the U. S. Tax Court has decided a case concerning a documentary filmmaker and her right to make certain expense deductions on her federal tax return related to the production of her documentary. Storey v. Commissioner, No. 10230-10 (U.S. Tax Court 2012). The IRS opposed the deductions claiming that the filmmaker was indulging a hobby not conducting a business and had no intent to make a profit from the film.
Lisa Storey is an Arizona water rights attorney and partner in her law firm. She has always had a theatrical interest and directed several plays for a not-for-profit group and served as the President of the group’s Board of Directors. She is also a sculptor and has received commissions for her work. In 2008, Storey produced the documentary “Smile ‘Til It Hurts: The Up With People Story”. The documentary concerns the youth group Up With People, which was formed in the late 1960’s as a retort to the anti-Vietnam war movement. The members of the group were clean cut, preppy types. They even performed at four Super Bowls. The group was disbanded in 2000. The documentary explored the movement, the effect of the group on its members and the organization’s finances.
Years into their marriage, Storey’s husband finally revealed to her that he had been a singer with Up With People. Storey became fascinated with the group and determined that it would be a fitting subject for a documentary film. And she went at it full force. In 2004, while she was practicing law full time, Storey took a month long course at New York Film Academy and filmmaking courses at a local community college. Storey then attended a reunion of Up With People alumnae and hired a film production company to conduct interviews with the former group members in attendance. Storey conducted interviews totaling 400 hours, did extensive research into the group, hired a professional research firm to assist with forensic accounting research, licensed the right to the group’s archival footage, and produced a 30-second promo reel in 2004 and 2005.
In 2006, Storey produced a film trailer and was accepted at the Sundance Institute’s Independent Producers Conference in where the idea for her film was “called out” as a viable product. Next, Storey set up an LLC for the purpose of producing the film, secured a bank account and credit card for the LLC, began production in 2007, hired professionals (including editors) to produce and post-produce the film, licensed all third party material incorporated into the film, obtained general liability insurance and an insurance “entertainment package,” sought investors and, when that failed, got a bank line of credit. Along the way, Storey turned down funding from Up With People believing that would compromise her integrity as a filmmaker. Storey hired a bookkeeper and an accountant, conducted screenings of the film’s “rough cut” in several markets to get audience feedback and edited the film accordingly. Storey attended the invitation-only Independent Film Producers’ Independent Film Week Conference in New York, reviewed her rough cut with industry experts, and held a private screening for programmers/distributors. In 2008, Storey produced a final cut and a foreign version, hired a publicist and a sales agent (producer’s rep), attended film festivals and won several festival awards. Additionally, Storey produced merchandise to publicize the film, and screened the films in several markets including Tennessee, Oregon, Washington, Arizona and California. This list of activities is pretty typical of what most documentary filmmakers do. But keep in mind, Storey continued practicing law during this entire time and devoted evenings, weekends and the occasional week off to work on the film. Storey has made no profit from the film.
Storey also included a 4 minute interview with her husband in the film although she did not identify him as her husband. This fact had some importance to the court as we’ll see later.
In 2006, 2007 and 2008 Storey deducted film-related expenses on her federal returns. The IRS issued a notice of deficiency for each of those years claiming that her filmmaking activities constituted a hobby and not a business and that the film was motivated by Storey’s desire to learn about her husband’s past. Slip Op. at 18. The IRS also argued that since she was making the film for non-business reasons, she also had no intent to make a profit from that activity. On appeal, the plaintiff argued her filmmaking was a business not simply a labor of love and that her primary motive was not her husband but making a profit from the film. Id.
As to the IRS argument that Storey’s filmmaking activities were a hobby and not a business, the court noted that although a taxpayer may deduct business expenses incurred in carrying on a business, there are two criteria that a taxpayer must satisfy to be engaged in a business: “the taxpayer must be involved in the activity with continuity and regularity, and the taxpayer’s primary purpose for engaging in the activity must be for income or profit.” Id. At 19.
With regard to the profit motive, the court noted that the taxpayer “must show that profit was his predominant primary or principal objective.” Id. at 20. The court added that the expectation of profit doesn’t have to be reasonable “but it must be bona fide” based on the facts of the case. Id. The court used nine factors to determine whether a person is engaged in a business for profit (no one factor controls the outcome and some of these factors may not be as important as others or even applicable depending on the facts of each case; even a majority of the factors favoring one side or the other may not control).
The manner in which the taxpayer carried on the activity
The court noted that several factors may indicate a project motive: did taxpayer have a business plan, did taxpayer make changes in an effort to earn a profit, did taxpayer maintain complete and accurate books and records and did plaintiff advertise the film. Id. at 22. The court concluded that Storey had done all of these things. The court added that the film was not a tribute to her husband even though his four-minute interview was included in the film.
The Expertise of Taxpayer or Advisors
The court noted that Storey had developed her own filmmaking expertise and had sought advice from industry experts.
The Taxpayer’s Time and Effort
The court reviewed how much time and effort Storey had expended to produce the film. The court agreed with the IRS that Storey’s real business was working as a lawyer but the court disagreed with the IRS’s conclusion, noting that Storey’s position as a law firm partner gave her flexibility to pursue her filmmaking activity adding that a taxpayer can engage in more than one business at a time. The court emphasized that “business:” can include the arts. Id. at 28.
Expectations That Property Used in the Activity Will Appreciate
The assets in this case were Storey’s film and her rights to Up With People archival footage. Storey claimed these assets would appreciate in value. The IRS argued that her rights in the footage have no value because she paid nothing to obtain them. The IRS also predicted that her film would make no profit. The court noted this factor had limited value because the assets she controlled were tied to the larger question of profit potential so that the court elected not to give this factor much weight but added that the factor slightly favored Storey because the praise and awards she had received for the film was some indication of potential value. Id. at 29.
Taxpayer’s Success in Other Similar Activities
The court noted that Storey had some success in directing theatre and sculpting. The court added that it could consider Storey’s success in unrelated activities to determine a profit motive citing Storey’s success as an attorney. Since the film was Storey’s first foray into the medium, the court noted this factor had limited value.
Taxpayer’s History of Income or Losses/ Amount of Occasional Profits
The court considered these two factors together. The IRS argued that since Storey had a record of continuous losses from filmmaking she was not engaged in filmmaking for profit. Storey acknowledged her losses but she expected to make money eventually, citing the praise she had received for the film and her marketing efforts through a marketing firm. Storey also noted that the economic crisis in this country had stymied her profit efforts. Storey pointed to the reality that regular commercial businesses often have losses in the startup stage. The court treated the three years at issue as part of Storey’s startup phase acknowledging that “a startup period may be longer in the arts, depending on the taxpayer’s facts and circumstances.” Id. at 31. The court also noted that circumstances beyond Storey’s control (the economic crisis) may also explain the lack of profit although he court did not quantify the impact the crisis may have had. Id. The IRS argued that Storey’s refusal of Up With People investment money shows Storey did not act in a businesslike manner. The court acknowledged that Storey’s rejection of that investment was meant to preserve her independence as a filmmaker. The court ultimately did not give much weight to these factors because Storey had been in a startup phase during the years at issue.
Financial Status of Taxpayer
The court agreed with the IRS that Storey’s income from her legal career was sufficient to offset her filmmaking losses. Id. at 32. This factor did not favor Storey.
Elements of Personal Pleasure
This factor looks at the elements of pleasure/recreation Storey enjoyed during the filmmaking process. The court noted that even if Storey enjoyed the process, this factor was not sufficient to classify her work as a hobby if other factors suggested a profit motive. Id. at 33.
The court summarized as follows: the factors that did not favor Storey were a history of losses, significant income from other sources and the enjoyment factor. But these factors were outweighed by most of the other factors. The court concluded Storey was engaged in filmmaking for a profit. Id. at 33.
As you can see, the Tax Court goes through a very careful analysis of these nine factors and the facts of an individual taxpayer’s case. All documentary filmmakers must consider how their filmmaking activities will stack up against these factors in the event that the IRS challenges their federal tax returns where losses are claimed as deductions.