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Gaston v. Commissioner (T.C. Memo. 2021-107)

On September 2, 2021, the Tax Court issued a Memorandum Opinion in the case of Gaston v. Commissioner (T.C. Memo. 2021-107). The primary issue presented in Gaston was whether the petitioner engaged in acting as a trade or business in the tax years at issue and, if so, whether the petitioner is entitled to deduct any reported expenses relating to that trade or business.

Background: A Pink Cadillac

The petitioner is a former national sales director for the Mary Kay, Inc. (Mary Kay). She began working for Mary Kay in 1967 and reached the position of national sales director (NSD) in 1974. As an NSD, the petitioner was entitled to participate in Mary Kay’s deferred compensation program known as the Family Security Program (FSP), which she joined in September 1991.

Gaston v. CommissionerThe FSP imposed a mandatory retirement age of 65 and provided that, upon her retirement, the petitioner 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, the petitioner established the Gayle Gaston Sole Proprietor Profit Sharing Plan (plan).

The plan does not identify a specific line of business to which the plan relates, and the drafter of the plan testified that the plan was not created with respect to any particular trade or business of the petitioner. In 2010 petitioner retired from Mary Kay, having reached the FSP’s mandatory retirement age. In her career with Mary Kay petitioner was highly successful; accordingly, her annual distributions under the FSP were $518,779 and $513,284 for 2013 and 2014, respectively. That is a lot of concealer and blush.

Post-Mary Kay

After her retirement from Mary Kay, the petitioner took up a number of non-Mary Kay activities. The petitioner began to sell jewelry to her former Mary Kay associates. This activity remained small, with petitioner devoting little more than 10 hours per week to its progress.

After the Mary Kay organization cracked down and prohibited former national sales directors from selling to the Mary Kay cosmetics sales force, the petitioner 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.

Gaston Loss
But the IRS does.

The petitioner’s jewelry sales activity generated losses in each year at issue. Next, the petitioner also explored whether she could begin a hair care products venture that would manufacture certain hair care products in Peru and then import them to the United States for sale.

The petitioner did not, technically, ever produce a product for sale, and never, technically, moved beyond the stage of designing her requirements for a future product. With the exception of two trips in 2013 and 2014 to Lima, Peru, which also included personal leisure, the petitioner devoted only a few hours per week to this activity.

Acting’s in Her Blood

The petitioner also decided to start acting. Petitioner had a prior history in the entertainment business, having engaged in some production activity in the 1980s. Petitioner also has family connections to the entertainment industry: Her son was an actor in Japan and later a cinematographer, and her daughter is (and was during the years at issue) one of the most successful actresses in Hollywood.

Gaston JennySide note: Judge Marvel alludes to the daughter of the petitioner as being one of the “most successful actresses in Hollywood,” but she does not name who this actress might be. The petitioner’s daughter is none other than Princess Buttercup (The Princess Bride), Jenny Curran (Forrest Gump), and Claire Underwood (House of Cards)—Robin Wright.

To further her acting activity the petitioner retained an assistant, who helped her identify casting opportunities and manage her applications. The petitioner 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.

The petitioner devoted significant time to this activity. Between the preparatory work, securing auditions, and acting in roles she secured, the petitioner personally spent at least 40 hours per week on her acting activity. The petitioner worked hard at this activity, but she also enjoyed acting.

Although the petitioner did not generate a profit from the acting activity in the years at issue or in subsequent years, by 2011, she had secured her first film credit. In 2013, the petitioner performed in at least one feature-length film. By 2019, the petitioner had secured at least 10 film credits and various other roles in commercials.

The Tax Issues

Upon receiving her distributions from the Mary Kay FSP in 2013 and 2014, the petitioner 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, the petitioner 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, the petitioner also claimed deductions for numerous expenses relating to her acting activity. Additionally, in each year petitioner claimed passthrough loss deductions from her S corporation on Schedules E, Supplemental Income and Loss, which were generated by her jewelry sales activity.

Gaston ExamThe petitioner’s 2013 and 2014 returns were selected for examination. On September 12, 2017, the IRS issued a notice of deficiency that disallowed the petitioner’s claimed acting activity expense deductions, her claimed passthrough loss deductions from her jewelry activity, and her claimed deductions for retirement contributions and determined income tax deficiencies, additions to tax, and penalties for petitioner’s tax years 2013 and 2014.

On December 12, 2017, the petitioner, while residing in California, timely petitioned the Tax Court for redetermination of the deficiencies, additions to tax, and penalties.

Proving Ordinary & Necessary Business Expenses

Whether a taxpayer may deduct an expense of an activity as an ordinary and necessary business expense 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, Wolf v. Commissioner, 4 F.3d 709, 713 (9th Cir. 1993), aff’g T.C. Memo. 1991-212, and
  2. the taxpayer can substantiate the reported expense as an ordinary and necessary business expense, see IRC § 183; Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), aff’d without published opinion, 702 F.2d 1205 (D.C. Cir. 1983); see also Treas. Reg. § 6001; Treas. Reg. § 1.6001-1(a).

The IRS conceded that the petitioner actually paid the reported expenses; therefore, the Tax Court was left to determine only whether the expenses that the petitioner paid were ordinary and necessary expenses of a business activity in which she engaged with objective that was predominantly, primarily, or principally profit (alliteration in original).

Petitioner Intended To Profit From Her Acting Activity.

In determining whether a taxpayer engaged in an activity with “the predominant, primary or principal objective” of making a profit, the Tax Court considers all the facts and circumstances. See Wolf, 4 F.3d at 713; see also Treas. Reg. § 1.183-2(b). The Tax Court pays particular attention to the factors set out in Treas. Reg. § 1.183-2(a)-(b):

  1. Gaston Profitthe manner in which the taxpayer carried on the activity;
  2. the expertise of the taxpayer or his advisors;
  3. the taxpayer’s time and effort expended in carrying on the activity;
  4. the expectation that assets used in the activity may appreciate in value;
  5. the taxpayer’s success in carrying on other similar or dissimilar activities;
  6. the taxpayer’s history of income or losses 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. the presence of personal pleasure or recreation.

No one factor is controlling, and the Tax Court considers the totality of the facts, giving greater weight to the objective evidence than to the taxpayer’s statements of intent. Overall, however, the critical question is the presence or absence of the taxpayer’s intent to profit from the activity, not necessarily the taxpayer’s actual success in that regard. An objectively “reasonable expectation of profit is not required.” Dreicer, 78 T.C. at 645. The Tax Court requires only that the taxpayer engage in the activity with the primary purpose of making a profit. Wolf, 4 F.3d at 713.

Gaston ActingThe petitioner alleged that she approached the development of her career in a businesslike way by retaining an assistant and a casting agency to help her identify and apply for auditions for roles. Finally, the petitioner asserted that, while she did not generate significant revenue during the tax years at issue, in more recent years she has secured several film roles on the basis of her early efforts to establish herself during the years at issue.

When analyzing whether particular taxpayers have proven that they entered into acting activities with an intent to profit, the Tax Court has considered such industry-specific factors as whether the taxpayers:[1]

  1. belong to an acting network or union;
  2. take classes or otherwise formally develop their skills;
  3. develop industry contacts;
  4. seek or secure multiple auditions or roles;
  5. advertise their services;
  6. prepare headshots or a portfolio;
  7. retain an agency or assistant to help secure roles; and
  8. maintain their efforts over time, given the nature of the industry.

In the light of these factors and those listed in Treas. Reg. § 1.183-2(b), the Tax Court concluded that the petitioner intended to profit from her acting activity and that her intent to make a profit from acting was her principal objective.

(T.C. Memo. 2021-107) Gaston v. Commissioner

Footnote:

[1] See Richards v. Commissioner, T.C. Memo. 1999-163; Green v. Commissioner, T.C. Memo. 1898-599; Regan v. Commissioner, T.C. Memo. 1979-340.

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