An Audit Nightmare Turned Artist Victory: An Interview With Susan Crile

This article originally appeared in ArtFCity on 12/15/16. Updated 7/22/2021.

American businesses sometimes lose money. Those losses actually create a tax shelter for other income. While the tax code explicitly provides this incentive for businesses – to encourage investment for growth, and to allow for unpredictable events – losses that go on for too long tend to draw scrutiny from the IRS.

If your arts practice loses money for more than a couple years, they may question the legitimacy of the business – specifically, the profit motive. Typically, they reclassify such a business as a hobby, and disallow the artist from expensing deductions past the point of their income from the activity. That’s bad news for any artist, but it was a near nightmare scenario for artist Susan Crile.

Crile spent eight years in tax court (from 2005-2013), defending her right to take losses. She is an accomplished artist by any measure. She has had over 50 one-person exhibitions, and her work is represented in dozens of museum collections, including the Guggenheim, the Metropolitan Museum of Art, The Hirshhorn, and the Cleveland Museum of Art. She is also a tenured professor of art at Hunter College.

However, despite this decades-long professional history, the IRS threatened to reclassify her art as a hobby, disallow her losses, and force her to pay over $200,000. In the end, Susan Crile won on the question of being considered a professional artist, and the precedent that her case set is that her day job was clearly judged to be a separate profession—not the reason for her art. But the judge did not rule on the allowability of her large deductions—that piece was sent to a settlement, and not all of the deductions were allowed.

In this interview, we discuss how she proved her case, what it took, and what she recommends for artists in a similar position.

Hannah Cole: First I wanted to thank you for putting yourself through what you have. You set a precedent that really helps other artists.

Susan Crile: I’m still recovering from it! I was very lucky that the law firm Cravath Swaine & Moore took it on pro bono, but my accounting was not taken care of pro bono. So I’m still getting my feet back from that.

HC: How did the audit start? I assume you got a letter in the mail and I want to know what went through your mind. (PSA to readers: an IRS audit always begins with a notice in the mail. If you receive a phone call announcing an audit, it is a scam.)

SC: Well I’ve been audited several times over the years and I hadn’t had any problem. I never had to pay anything. But this time it seemed as if there was no reason for it and my accountant [and I] both thought that we should question it. So, it was going in a normal way up the audit chain and suddenly something changed. No one’s been able to figure out what happened. By the time it got to the appeals they had decided that I was a hobbyist, that we had to pay this huge amount [in back taxes, penalties and interest] and had added seven years to the audit.

Early on it wasn’t a huge amount disputed—about ten thousand [dollars] in deductions.

HC: Wow. For the readers’ information, both hobbyists and professional artists must report all income, but in the years of her audit, a hobbyist could deduct expenses up to the amount of their hobby income. A professional artist, in business to make a profit, could then and can still claim expenses beyond income. In other words, they can claim a loss. Please note: in 2018, the Tax Cuts and Jobs Act changed the rules for hobbyists, so that as of 2018, hobbyists may no longer deduct any expenses at all. The rules for business deductions remain unchanged.

SC: So I think there were two things that made them decide to [expand and shift the focus of the audit]  First, I think that they were probably looking for someone to use as a test case.

HC: That’s my suspicion as well.

SC: Second, my deductions were high and my income was very variable year-to-year. I also had a full-time teaching job. There were a lot of variables in there, and if they could get me, they could get a lot of people, all of whom would be omitted from taking deductions.

HC: This would allow the IRS to classify all similarly situated artists as “hobbyists,” and therefore not entitled to take a loss.

SC:  Yes. The IRS kept changing why they were taking this route. By the time the law firm Cravath Swaine and Moore came in, they were not interested in settling at all. The first thing Cravath Swaine and Moore did was send them about a thousand pages of backup. This was five years before the judgement.

HC: That’s amazing.

SC: So the audit started in 2004 or 5 went to trial in 2013 maybe ended in 2014.

HC: So how were you feeling when all of this went down? It doesn’t sound like the initial audit letter was that much of a shock.

SC: No. For the first year there was nothing about it that was really terrible. But when they started adding on years and the numbers of what I was going to owe started getting revised up I got scared. They weren’t going to allow me any deductions at all [beyond SC’s art income]. Then I would have been subject to The Alternative Minimum Tax.

HC: This tax was intended to ensure that high-income taxpayers, who may be savvy about maximizing deductions, pay at least a certain amount of tax.

SC: It began to look really onerous. At that point I went to Cravath Swaine and Moore. I knew one of the partners very well.They decided to take it on pro bono. It was just luck that I was able to be in that position.

HC: Wow, that’s amazing. I’m curious to know what you learned going through that experience?

SC: I don’t think anyone should get tangled up with the IRS if they don’t have to, for one. You get mauled. And unless you’ve got really really good backing and coverage, it’s really hard.

HC: Can you explain what backing and coverage means? It seems useful to mention here that the IRS uses nine points to determine whether a person incurring losses in their business has a profit motive. The profit motive is the key factor that determines the legitimacy of a business in the eyes of the IRS, and having one entitles the business to incur losses. Otherwise, the activity is deemed a hobby, and losses are disallowed.

SC: You have to have a really good accountant who knows and understands the law. The nine points are not just about demonstrating a profit alone. It is a preponderance of points and a lot of them relate to how you run your business.

HC: Right, they are given different amounts of weight in the judgement. Like the fact that you hired a professional bookkeeper, an accountant, and someone to digitize your inventory for a few big years, all play into the point about the expertise of the taxpayer and his advisors. You wouldn’t hire those people if you were a hobbyist.

SC: Yes. You have to have records and proof. Letters you’ve written trying to contact curators and museums, or trying to get gallery representation. I had to go through my date book and annotate everything I took for a deduction and why it was valid. If people get into the habit of good record-keeping and note-taking, they’re probably not going to have a problem.

Fortunately, I had decided early on that I wanted to know where my artwork was, so I have kept track of it. A lot of people I know don’t. Even when we went through [it], my sales were a lot more than what they said they were. We only could count those that I have proof of.

HC: That really puts a fine point on it.

SC: It took a huge amount of time out of my life. I mean, having to substantiate every move you’ve made for seven years. That, and I had to basically go through and count the amount of work I’ve made. I had to inventory everything…I had to dig up stuff from storage and boxes of stuff. In terms of figuring out sales, I had to go back forty years on every single thing I had ever done.

HC: Wow. That’s really incredible.

SC: It’s much harder for me, too, because I can’t do everything electronically. I’m older and not absolutely terrific with all the electronic stuff.

HC: It’s interesting that you say that because you are proof that the old-fashioned way is just fine if that works for you.

SC: Did you read the trial? Because they brought in this woman as their expert — Elizabeth von Habsburg, who tried to claim that I had no records because I had not gone electronic with everything.

HC: Right and she was an IRS expert witness, the managing director of Winston Art Group, who was brought in to testify regarding the art market and art appraisal.

SC: A good part of my  work had been digitalized, not just 1980-85.  Most everything from 1980 on has been digitalized, but my work goes back to 1965.

She was trying to say that because I hadn’t gotten everything digitally [catalogued] that I was an amateur. We have these boxes that I had had from the earlier time that had listed on them what I sold and to whom. It was a different form of doing it, but I had it.

I had an appraiser come in and take a look at my work in the country and what I have done here in New York. We came out very well on that because I have things wrapped properly and indicated on the back what the work was, and where it had been shown.

HC: The Hobby Loss Rule says that so long as you make a profit in three out of five years, you are presumed to be in business with an intent to make a profit. If not, you are presumed to be conducting a hobby.

SC: So you’re actually innocent until proven guilty, but they act as though you’re guilty until proven innocent.

HC: It’s a question of onus. When you make a profit in three out of five years, the onus is on the IRS to prove that you don’t have a profit motive. But the issue that arises when you run losses for more than three out of five years is that you are presumed to not have a profit, and you have to prove that you do. So that is written in The Internal Revenue Code.

SC: They act as if you are absolutely wrong, as opposed to acting on the assumption that you can give them evidence that you are not. That was the sense that I got all the way along. That they were cut hard and dry that the law is if you don’t have [profit] three out five years then you are wrong, and you owe us.

HC: An artist running losses is in the position of threading that needle. You have to say here are my losses, but here’s the case law that says that that doesn’t disprove my profit motive.

SC: And I think that most people who come up against the IRS don’t know that. They are intimidated by it.

HC: It’s my experience that sometimes the auditors don’t know what the law actually says, and that the person being audited ends up in the position of having to educate the auditors about the case law.

SC: That’s hard for me to have an opinion about because I left it entirely to my accountant. I didn’t go to the audit. What I heard from my accountant was pretty shocking. At one point one of the auditors said “I have art books on my coffee table and I can’t take them as a deduction, why should she?”

HC: Wow.

SC: I mean, please. Don’t you have accounting books or tax law books? I think one of the real problems is that there’s a lot of cultural envy. In an odd kind of way they feel that we’re getting away with something.

It’s complicated too because so much of what we do in our lives is potentially deductible. That came up in the trial in the final deliberations with the judge who felt that that there had to be some demarcation points. He sent us back to negotiate on what deductions were viable, and what were not. Not that I wasn’t an artist in it for profit, but were all these deductions correct.

HC: Has the settlement part been decided?

SC: That was decided, and it took a year and three months. We only used one year as a model and applied it to the rest. At the onset of this seven years, with penalties and interest, and taking out every single deduction, it could have been over $200,000 that I owed. 

HC: Oh my goodness.

SC: During the negotiations, the IRS examiners offered to give me only 10% of my deductions—as though the trial had never happened! My lawyer was just fantastic. She had the patience of Job, and she just wore them down. And in the end, we got close to 85% of my deductions. It should have been a lot higher but we had to compromise at some point. [The IRS] just did not want to budge an inch on anything. We just let go of certain categories they had problems with.

HC: What about the day job aspect of the trial? Because even in the era of Churchman v Commissioner (who ran loses as an artist for 20 years and won her case) they were trying to prove that if you had a day job the fact that you weren’t living off of your art meant that you didn’t have a true profit motive. But what your trial proved, in my understanding, is that the day job does not invalidate the legitimacy of your arts practice.

SC: That was a huge piece of it. The IRS started with a hobbyist routine and when they found out that I had this massive amount of stuff — that I actually have exhibitions, I have sales, I had excellent reviews, they weren’t willing to back down and say, “ok she is in it as a business to make a profit.” They just switched, and said “okay, the only reason she is showing her work and trying to have it exhibited to keep her job as a professor”. Which is totally ludicrous. I had already been tenured and was a full Professor by 1995. It hard to fire a teacher with that status. That was not a very strong argument for the IRS. The judge wrote that this would invalidate so many areas for people who teach and was explicit in his rejection of this argument.

HC: For sure. I know a lot of artists who are serious professional artists working very hard, but running losses more than the three out of five years.

SC: You are in the position of having to educate your clients.

HC: Yes, I mean it’s one thing to think of an audit in very theoretical-someday-low-possibility terms and be running your practice. But when you realize the kind of thin ice you’re walking on if you’re taking losses, and you realize your entire defense is based on that record keeping, it definitely shores up your resolve to keep it as professionally as you’re able.  Do you think that it was all worth it?

SC: It’s worth it if it helps other people.

HC: Are there any last words that you would want to leave other people in the art world with?

SC: I think we all have to make sure that artists can continue to take deductions [including to the point of losses], because the art world is mimicking the real world – there’s the billionaires and the rest of us. The only way in which we can continue to be able to work is if we are also able to take losses.

DISCLAIMER: True tax advice is a two-way conversation, and your accountant needs to hear your full situation to apply the rules correctly in your case. This post is meant for general information only. Please don’t act on this alone.

Hannah Cole is an artist and Enrolled Agent. She is the founder of Sunlight Tax.