Tax Court Holds That Retiree's Acting Career Was a Trade or Business

(Parker Tax Publishing September 2021)

The Tax Court held that a taxpayer who took up acting after retiring from her job as a sales director engaged in acting as a trade or business, even though the acting activity did not generate a profit during the years at issue. The court found that the amount of time the taxpayer spent researching and auditioning for roles, the voice and dance lessons she took, and her hiring of an assistant and an agent indicated that she engaged in acting with the intent to supplement her post-retirement income, and therefore that her principal objective was to make a profit. Gaston v. Comm'r, T.C. Memo. 2021-107.

Background

Gayle Gaston is a former national sales director (NSD) for Mary Kay, Inc. (Mary Kay). As an NSD, Gaston was entitled to participate in Mary Kay's deferred compensation program known as the Family Security Program (FSP). The FSP imposed a mandatory retirement age of 65 and provided that, upon her retirement, Gaston would be paid a monthly distribution scaled to a percentage of the average of her three highest commission years during the five years before retirement.

In 2008, two years before she reached the mandatory retirement age, Gaston established the Gayle Gaston Sole Proprietor Profit Sharing Plan (plan). The plan was drafted by Dennis Mehringer. The plan document did not identify a specific line of business to which the plan relates, and Mehringer testified that the plan was not created with respect to any particular trade or business of Gaston. In 2010, Gaston retired from Mary Kay, having reached the FSP's mandatory retirement age.

After her retirement from Mary Kay, Gaston took up a number of non-Mary Kay activities. First, she began to sell jewelry to her former Mary Kay associates. This activity remained small, with Gaston devoting little more than 10 hours per week to its progress. After the Mary Kay organization prohibited former NSDs from selling to the Mary Kay cosmetics sales force, Gaston attempted to sell her jewelry to the general public but spent very little time or effort doing so, and she ceased her jewelry sales activity shortly thereafter. Second, Gaston also explored whether she could begin a hair care products venture, but never produced a product and never moved beyond the planning stage.

In addition to these two activities, Gaston also decided to start acting. Gaston has family connections to the entertainment industry: Her son was an actor in Japan and later a cinematographer, and her daughter, Robin Wright, is one of the most successful actresses in Hollywood. To further her acting activity, Gaston retained an assistant, Josline Giragossian, who helped her identify casting opportunities and manage her applications. Gaston also engaged various casting services, retained an agent and a business management company, secured professional headshots, advertised her skills, and took acting and voice lessons. Gaston spent at least 40 hours per week on her acting activity. Although she did not generate a profit from the acting activity in the years at issue (2013 and 2014) or in subsequent years, by 2011 she had secured her first film credit. In 2013, Gaston performed in at least one feature-length film. By 2019, Gaston had secured at least 10 film credits and various other roles in commercials.

Upon receiving her distributions from the FSP in 2013 and 2014, Gaston contributed $51,000 from each year's distribution to the retirement plan she had established in 2008. On each of her 2013 and 2014 income tax returns, Gaston reported the distribution from the FSP as income from a sole proprietorship on a Schedule C and claimed a deduction for the contribution to her retirement plan. On each Schedule C Gaston also claimed deductions for numerous expenses relating to her acting activity. Additionally, Gaston claimed passthrough loss deductions from her S corporation which were generated by her jewelry sales activity. The IRS disallowed Gaston's claimed acting activity expense deductions, her claimed passthrough loss deductions from her jewelry activity, and her claimed deductions for retirement contributions. Gaston took her case to the Tax Court.

The deductibility of an expense of an activity as an ordinary and necessary business expense under Code Sec. 162 turns on whether: (1) the taxpayer can establish that she engaged in the activity as a trade or business; i.e., the taxpayer engaged in the activity with the predominant, primary or principal objective of making a profit, and (2) the taxpayer can substantiate the reported expense as an ordinary and necessary business expense. Reg. Sec. 1.183-2(b) provides a list of factors that determine whether, under all the facts and circumstances, the taxpayer is engaged in an activity with the predominant, primary or principal objective of making a profit. These factors include the manner in which the taxpayer carried on the activity and the taxpayer's time and effort expended in carrying on the activity. In Richards v. Comm'r, T.C. Memo. 1999-163 and other decisions, the Tax Court has considered industry-specific factors to determine whether particular taxpayers have proven that they entered into acting activities with an intent to profit. With respect to a trade or business involving acting, these factors include: (1) belonging to an acting network or union, (2) taking classes or otherwise formally developing their skills, (3) developing industry contacts, (4) seeking or securing multiple auditions or roles, (5) advertising of services, (6) preparing headshots or a portfolio, and (7) retaining an agency or assistant to help secure roles.

Gaston argued that the principal objective of her activity was to make a profit because she took up acting as a way to help supplement her income after retiring from Mary Kay. She asserted that she approached the development of her career in a businesslike way by retaining an assistant and a casting agency. Gaston conceded that the revenues reported on her Schedules C actually represented payments from the Mary Kay FSP and, accordingly, did not relate to the expenses for her acting business. However, she argued the payments represented self-employment income subject to self-employment taxes. Gaston reasoned that because FSP payments are taxable self-employment income, they must also be "earned income" under Code Secs. 401(c)(2)(A) and 404(a)(8)(B). As a result, Gaston asserted that the contributions she made from the FSP payments to her profit-sharing plan were deductible under Code Secs. 401 and 404.

The IRS argued that if Gaston truly had a profit motive, she could have secured far more bookings than she did simply by consulting with her daughter. Moreover, the IRS contended that Gaston gained substantial enjoyment from working in the same industry as her daughter and therefore could not have had a bona fide intent to make a profit. The IRS also noted that Gaston had never generated a profit from her acting activity and thus could not have engaged in the activity with an intent to profit. The IRS contended that Gaston's retirement contribution deductions should be disallowed because Gaston was retired and not engaged in any trade or business, Mary Kay-related or otherwise, and further that Gaston had no earned income within the meaning of Code Sec. 401(c)(2)(A).

Analysis

The Tax Court held that Gaston was engaged in the trade or business of acting after finding that the principal objective of her acting activity was to make a profit. The court noted that Gaston secured roles in feature-length films, including one in 2013. She spent approximately 35 to 45 hours per week researching, applying, and auditioning for roles and trained to enhance her skills through acting and voice lessons. To assist her in securing roles, she retained an assistant and an agent. The court said that, taken together, these actions showed that Gaston carried on her affairs in a businesslike manner, with substantial investment of time and effort. Rejecting the IRS's arguments, the court reasoned that Gaston was not required to bootstrap her daughter's successes to secure her own, and that while Gaston may have enjoyed working in the same industry as her daughter, that did not negate Gaston's intent to profit from her work. In addition, the court found that while a history of losses is one factor to consider in determining whether the taxpayer's principal objective is making a profit, the presence or absence of profits is not determinative.

However, the court found that only some of Gaston's claimed expenses were deductible. Gaston conceded that she could not meet the heightened substantiation requirements imposed by Code Sec. 274(d), so the court went on to consider whether Gaston had proved she could deduct any reported expense not subject to Code Sec. 274(d). The court allowed Gaston's expenses for headshots, casting agency subscriptions, and voice and dance lessons, after finding that these expenses are inherently connected with acting. In addition, the court estimated that 75 percent of Giragossian's work hours related to Gaston's acting business, with the rest allocated to her jewelry and hair care activities. The court disallowed all of Gaston's claimed expenses relating to her jewelry activities after finding that she did not conduct that activity in a businesslike manner and did not do anything meaningful to elevate the activity to a business capable of generating a profit.

The Tax Court also held that Gaston could not deduct the contributions she made to her retirement plan. The court explained that, in order to deduct the contributions, Gaston was required under Code Sec. 404(a)(8)(C) to show that the plan was established with respect to her Mary Kay business, which was the undisputed source of the income at issue. But the court noted that the plan document did not identify to which trade or business the plan related and that Mehringer testified that the plan was not created with respect to any specific trade or business.

For a discussion of determining whether an activity is engaged in for profit, see Parker Tax ¶97,505. For a discussion of deducting contributions to self-employed retirement plans, see Parker Tax ¶80,110.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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