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The first hurdle visual artists often have is the question regarding whether their "art" is indeed a business for tax purposes. The heart of this matter is whether the I. R. S. sees the endeavor as a real "business" or as a "hobby." Because the artist’s ventures often (sadly) yields losses, the question then becomes when does the tax code determine an enterprise to be a true business as opposed to a hobby. Here's how you may be affected by these so-called "hobby" rules.

Although you must claim the full amount of income you earn from your hobby, hobby-related expenses are generally deductible only to the extent of income produced by the activity. So if you don't generate any income from your hobby, you can't claim any deductions. What's more, even those hobby expenses which can be deducted are subject to an additional limitation: they are considered miscellaneous itemized deductions on Schedule A, which are deductible only to the extent that they exceed two percent of your adjusted gross income. In contrast, if your activity can be classified as a bona fide business, you may be able to deduct the full amount of all your expenses by filing a Schedule C. In short, a hobby loss won't cut your overall tax bill because the tax law stipulates that you can't use a hobby loss to offset other income.

Converting your hobby into a bona fide business means you can deduct a net loss from other income you earn, such as wages and salaries. How does the IRS determine whether your activity is a hobby or a for-profit business? The Internal Revenue Service publications discuss these nine criteria:

1. Whether you carry on the activity in a businesslike manner.
2. Whether the time and effort you put into the activity indicate you intend to make it profitable.
3. Whether you are depending on income from the activity for your livelihood.
4. Whether your losses from the activity are due to circumstances beyond your control (or are normal in the start-up phase of your type of business).
5. Whether you change your methods of operation in an attempt to improve the profitability.
6. Whether you have the knowledge needed to carry on the activity as a successful business.
7. Whether you were successful in making a profit in similar activities in the past.
8. Whether the activity makes a profit in some years, and how much profit it makes.
9. Whether you can expect to make a future profit from the appreciation of the assets used in the activity.

The primary determinant is your ability to make a profit at what you are doing. If your efforts result in a profit in three out of five consecutive years, your activity is presumed not to be a hobby by the IRS. If you don't meet the three-out-of-five years profit rule, is all lost? Not necessarily, if you can prove to the IRS's satisfaction that you have made a genuine effort to earn a profit and that the reason you are not successful is related to special circumstances, the IRS might agree that your art is, in fact, a business. This is often true for individuals engaged in the arts, where profits and successes are difficult to achieve. To increase your chance of gaining the IRS's recognition of your business, I recommend that you run your activity in a professional, businesslike manner. Doing such things as having business cards and stationery printed, maintaining a separate business checking account and telephone number, keeping accurate records of the time you put in, and carefully documenting all business-related expenses. The Internal Revenue Service places great credence on computerized accounting records as evidence of the artist’s "businesslike" intent. Keep records of all show entries (even including ones that you don’t get into) and all gallery activity. In short anything related to attempts to sell your artwork.

Income

Income for the artist includes amounts paid to the artist for their artwork. Income for the artist also includes prizes, awards, fellowships, and endowments received. There is also the concept of "taxable income other than cash." This includes trades of art between artist and other individuals. For example: an artist agrees to "sell" a painting to another artist by exchanging artwork. The painting that the first artist gives up "costs" $75 (the cost of paint, canvas, and framing). The artwork received has a market value or price of $1,000. The first artist will have a taxable income from this transaction of $925 ($1,000 less $75). In other words the artist received something worth $1,000 but only paid $75.

Travel & Meals

The artist is allowed to deduct all expenses associated with overnight business travel. These include meals (only 50% deductible), hotel & lodging, reasonable tips, dry-cleaning, phone calls home, etc. Overnight travel is roughly defined by the IRS as travel that is far enough away from home so as to make it inconvenient to return home at night. Travel could include expenses related to gallery visits, openings of shows, delivering artwork, art fairs, etc. and will include many of the expenditures made on such trips. The other question often asked is the travel deduction for mixed vacation/business travel. As long as the trip is primarily business then deductibility will be maintained. For example, what if the artist has a five-day trip to NYC for a gallery opening and outdoor art fair that includes a two-day stopover in Philadelphia on the way home to visit a friend. In this case the entire NYC trip would be deductible but the expenses related to the Philadelphia stopover, which was personal would not be. Since maintaining individual meal receipts is inconvenient, consider using the IRS "meal allowance" for deducting meals when traveling. This "meal allowance" (adjusted annually by the IRS) ranges from $30 to $40 per day depending on the location. In practice this means that receipts for meals are not required as long as the travel itself can be substantiated. This "allowance" includes all three meals and incidental expenses for the day. Travel for spouses or dependents are not allowed unless they are employees of the art business.

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Peter Jason Riley, CPA is the author of The New Tax Guide for Artists of Every Persuasion, the only complete tax guide available specifically for the working artist.