In a court case closely watched by documentary filmmakers throughout California, Lee Storey, the producer and director of “Smile ‘Til It Hurts: The Up with People Story,” has prevailed in her tax dispute with the IRS. The tax controversy began a few years ago after the filmmaker sought to deduct her losses from making “The Up with People Story.” However, the IRS denied the deduction, saying her filmmaking pursuits were a hobby rather than a business.

Under the tax code, Californians who are engaged in a business venture may be able to write off any losses accrued from that venture. That is not the case, though, with hobbies. In distinguishing between the two, the IRS looks at whether the activity produced a profit, since the agency assumes that a person would only engage in a business if it was potentially profitable to do so. Therefore, if the business has not produced profits in at least 3 out of 5 years, the IRS assumes that the taxpayer was merely engaged in a hobby.

While making her documentary, Storey racked up substantial losses for six years in a row. However, she also earns a decent income as a lawyer in Arizona, so when she sought to write off her losses against her income, she attracted the attention of the IRS. The agency subsequently performed an audit, assessing her back taxes to be in the amount of $259,842.

However, in a decision that was widely lauded by many documentary filmmakers, a U.S. tax court judge ruled against the IRS. The judge stated that the filmmaker could write off all of the losses, and that documentary filmmaking is a unique business that may take a while to produce a profit. The positive resolution to the tax controversy is no doubt welcomed by many here in California, as the ruling demonstrates that some business ventures may take time to develop. The mere fact that a venture initially produces losses does not necessarily mean it is just a hobby.

Source: Forbes, “Maker Of ‘Up With People’ Knocks Down IRS In Hobby Loss Case,” Janet Novack, April 19, 2012