Are you an independent filmmaker? Wondering if the IRS will eviscerate your already precarious financial status? (For more on that, click here.)
Wonder no more: Not only can you take the nine-factor test right now in the privacy of your home, we've also provided a study guide to help you pass with flying colors.
(Note: Of course, this is only relevant if you intend to file for deductions related to your filmmaking expenses. However, for anyone who intends to make money at some point from their filmmaking, it's pretty great advice — though no substitute for professional consultation. And on that note, please make sure you have expert tax assistance from someone who knows the vagaries of this business.)
Here's the test, as provided by the IRS' own Audit Technique Guide, which is designed to help agents "in the application of Internal Revenue Code (IRC) § 183, Activities Not Engaged in for Profit (sometimes referred to as the “hobby loss rule”)."
Whether or not an activity is presumed to be operated for profit requires an analysis of the facts and circumstances of each case. Deciding whether a taxpayer operates an activity with an actual and honest profit motive typically involves applying the nine non-exclusive factors contained in Treas. Reg. § 1.183-2(b). Those factors are:
1. the manner in which the taxpayer carried on the activity,
2. the expertise of the taxpayer or his or her advisers,
3. the time and effort expended by the taxpayer in carrying on the activity,
4. the expectation that the assets used in the activity may appreciate in value,
5. the success of the taxpayer in carrying on other similar or dissimilar activities,
6. the taxpayer’s history of income or loss with respect to the activity,
7. the amount of occasional profits, if any, which are earned,
8. the financial status of the taxpayer, and
9. elements of personal pleasure or recreation.
Now, here's what the IRS is looking for. While none of this should be taken as official tax advice, attorney Michael Donaldson, counsel to the International Documentary Association as a "friend of the court" in the current IRS case vs. documentarian Lee Storey, has provided some guidance in what the IRS wants to see. Says Donaldson, "They don't require you to be a good, successful businessperson; they require that you are in a business."
▪ How the business is run. In short, does it seem to be run as any business would be, with accurate and complete files?
How to win: Donaldson recommends that the production have a separate bank account, with all associated filmmaking activity taking place out of that account.
▪ Expertise. Is there reason to believe that the filmmaker is capable of making a financially successful movie? This one can be difficult; every filmmaker is a rookie at some point. And not everyone goes to film school (a fact that would be in your favor here).
How to win: Donaldson recommends membership in professional organizations or evidence that you've sought professional advice.
▪ Time and effort. This one seems self evident — if you're making an independent film, you're expending nothing but time and effort. However, time in itself doesn't prove a profit motive — and filmmakers must also consider their profession's glamorous reputation, since the IRS tends to look down on activities that seem to be significantly recreational or otherwise fun. (Has the IRS ever been on an independent film set?)
How to win: Keep a production diary. Log your footage daily. "This is a very important piece," says Donaldson.
▪ Appreciation. Another hard one: Even if there's no current revenue (much less profit), the IRS wants evidence suggesting it's likely your assets will appreciate in value.
How to win: Make every effort to make money from your movie. Says Donaldson: "The IRS wants to know that it's reasonable to think you're going to try to sell the film."
▪ Success rate. Have you done this before? Successfully? "If you've done 9 to 5 all your life and never done anything entrepreneurial, you'd be facing an uphill battle," says Donaldson.
How to win: If you're a first timer, take comfort that there are nine factors to consider. However, any kind of entrepreneurial track record could be helpful here.
▪ History of income or loss. Losses happen all the time in business, but if you continue for years despite those ongoing losses, the IRS tends to see it as a hobby.
How to win: Always demonstrate a good-faith effort to make money on your movie. "If you made two or three short films and you never tried to sell them, it would look like a hobby," says Donaldson. Yes, it's a limited market; pursue it. "If you make no effort, it doesn't look like a business."
▪ Amounts of occasional profits. This one is particularly cruel: You spend years and untold sums making and distributing your movie and finally show some money — even a small profit. However, the IRS wants to know if these occasional profits are significant compared to the investment and the losses. An occasional small profit against a large investment or losses doesn't look good.
How to win: Focus on the other eight factors. "That one is a particular challenge," says Donaldson. "The courts have to look at the context of the business enterprise. It's one of the tougher ones for independent films."
▪ Financial status of owner. Basically, the IRS frowns on you working another job while you're incurring (and claiming) all these losses. This factor was one of the red flags in Storey's case: In addition to being a filmmaker, she's a well-paid tax lawyer. "If you're working a full-time job making a good salary, your leisure time activity is more likely to be considered a hobby," says Donaldson.
How to win: This one's a natural: Be poor. Live close to the bone, couch surf and basically do whatever you can to avoid having a straight job.
▪ Personal pleasure or recreation. Once again, indie film has to face the specter of its undeservedly glamorous reputation. People tend to think of filmmaking as fun (which it probably is, compared to working for the IRS) and the agency tends to discount activities that might be done for the sheer fun of it.
How to win: Provide evidence of the sacrifices made for your work.
For more information, read It's Not Just Documentaries: The IRS Could Turn Independent Film into a "Hobby."