Susan Crile spent 25 years as a professional artist. In all but two of those years, she reported losses on her tax returns. When the IRS came knocking with a deficiency notice that could cost her tens of thousands of dollars, they claimed her art wasn’t a real business—just an expensive hobby.
What happened next became one of the most instructive Tax Court cases for understanding how to defend business deductions against IRS challenges.
In episode 16 of Tax in Action, host Jeremy Wells, EA, CPA, breaks down Susan Crile v. Commissioner (Tax Court Memorandum 2014-202)—a case he considers essential reading for anyone working with self-employed clients. As Jeremy explains, “If you work with small business owners, I strongly recommend reading through this opinion.”
When Your Business Becomes the IRS’s Target
The hobby loss rule creates what Jeremy calls a “heads I win, tails you lose” situation for the IRS. Here’s why it’s so devastating for small business owners.
When the IRS decides your activity is a hobby rather than a business, the tax consequences are brutal. “The income from these kinds of hobby, sport or recreational activities is still included in taxable income,” Jeremy explains. “But the reverse is not true. Those losses are not deductible.”
Think about what this means. If you’re an artist who sells $10,000 worth of paintings but spends $25,000 on studio rent, supplies, and marketing, the IRS still taxes that $10,000 as income. But if they say you’re pursuing a hobby, you can’t deduct any of that $25,000 in expenses.
Since 2018, when the Tax Cuts and Jobs Act eliminated miscellaneous itemized deductions (made permanent by later legislation), hobby expenses have been completely nondeductible. You pay tax on every dollar coming in, but can’t offset any dollars going out. The only exception is cost of goods sold (COGS), as the cost of raw materials can still reduce gross income.
The burden of proving your activity is a legitimate business falls entirely on you. Courts won’t just take your word for it. As Jeremy notes, “I can say I’m hoping to make a profit someday, but the courts look at all of the objective factors that go into how I’m operating that activity.”
Who’s at Risk (And Who’s Not)
The hobby loss rule applies to nearly every small business structure: individuals filing Schedule C, partnerships, S corporations, estates, and trusts. But C corporations are completely exempt.
Jeremy points to Amazon as a perfect example. “Amazon was a C corporation pretty much from the start,” he explains. The company famously took seven to eight years before turning a profit. “There was a long time there where investors were nervous that Amazon was never going to be profitable.” Yet Amazon never faced hobby loss scrutiny because C corporations don’t have to worry about this rule.
Simply forming an LLC or electing S corporation status won’t protect you. “Just registering an entity such as an LLC or just making a tax election, such as electing to be an S corporation, doesn’t necessarily guarantee that that taxpayer is not going to have to worry about the hobby loss rule,” Jeremy emphasizes.
For partnerships and S corporations, the determination happens at the entity level, not the individual partner or shareholder level. That affects how losses flow through to individual tax returns.
Susan Crile’s David vs. Goliath Battle
Susan Crile was a tenured art professor at a university when she received IRS deficiency notices in 2010. The IRS was challenging tax years 2004, 2005, and 2007 through 2009—five years where her losses ranged from about $37,000 to $63,000 annually.
The IRS made two arguments. First, they claimed her art activity wasn’t engaged in for profit. Second, they argued that even if it was a business, it should be considered part of her work as an art professor, making the expenses unreimbursed employee expenses rather than business deductions.
Crile believed this was a test case. In an interview after the decision, she said she felt the IRS was exploring “the art industry as a whole to see how far it could go in terms of auditing artists.” Whether that’s true or not, her case established important precedents for creative professionals everywhere.
The Nine Factors That Saved Her Business
The Tax Court uses a nine-factor test from Treasury Regulation 1.183-2(b) to determine whether an activity has a profit motive. Jeremy notes that this framework actually came from earlier court cases. The courts created the test, and the Treasury later adopted it into regulations.
Here’s how each factor played out in Crile’s case:
1. The manner in which she carried on the activity
The court found Crile kept “relatively good records” of sales, galleries, and exhibitions. She worked with a bookkeeper for most years in question. But what really impressed the judge were her business decisions, like switching galleries when she realized her current venue no longer attracted buyers interested in her type of art. The judge concluded, “Petitioner’s marketing efforts demonstrate a profit objective.”
2. Her expertise and that of her advisors
The IRS tried arguing that while Crile could create art, she didn’t understand the business of selling it. The court thoroughly rejected this. The judge found she “understood the general factors that affect the pricing of art: a history of sales, gallery representation, solo exhibits, critical reviews, prestigious public accolades, and she worked diligently to achieve these credentials.” The court’s verdict? “She is, without doubt, an expert artist who understands the economics of her business.”
3. Time and effort expended
Crile spent about 30 hours per week on art during teaching periods and worked full-time creating art the rest of the year. But the court looked deeper, distinguishing between tasks necessary for any activity versus those “essential only because she was conducting a business.” Mundane business tasks like marketing, networking with collectors, and arranging shows would be unnecessary for a hobbyist.
4. Expectation that assets may appreciate
The court recognized that art is “a speculative venture where a single event, a solo show, a rave review or a museum acquisition can lead fairly suddenly to an exponential increase in the prices paid for an artist’s work.” Artists create inventory that might sit at low values for years before that breakthrough moment arrives.
5. Success in other activities
Crile had been an artist for over a decade before becoming a professor. Her academic success actually enhanced her standing with art professionals and expanded her clientele. This factor was relatively neutral in the case.
6. History of income or losses
This was Crile’s weakest point: she had only two profitable years in 25. Jeremy acknowledges “the IRS won this point.” However, the court noted that some losses might have resulted from improperly claiming personal expenses as business expenses. The 2008 financial crisis had also devastated the New York art market during several years under review. Most importantly, the court stated that “losses do not negate the petitioner’s actual and honest intent to profit from the sale of her art.”
7. Amount of occasional profits
With just two years of reported profits, this factor “weighed slightly in favor of the IRS.” But the court remained sympathetic, understanding that in the art world, one breakthrough can change everything.
8. Financial status
Crile had a salary from teaching, but she’d been an artist for over a decade before getting that job. She didn’t become an artist to shield other income from taxes. This factor was neutral.
9. Elements of personal pleasure
The court offered this memorable insight: “A level of suffering has never been made a prerequisite to deductibility.” Yes, Crile probably enjoyed creating art. But her extensive research, marketing efforts, and business operations took her activity “well beyond the realm of recreation.”
The Verdict That Protected Creative Professionals
When the court weighed all factors together, “both qualitatively and quantitatively,” the balance tipped in Crile’s favor. She had proven “an actual and honest objective of making a profit.”
The court found that her activity was indeed a business, allowing her to deduct ordinary and necessary business expenses, and any losses were deductible. As Jeremy summarizes, “Her professional conduct, demonstrated expertise, significant time commitment, and reasonable expectation of appreciation outweighed even decades of losses.”
Clearing Up the “Three-of-Five Year” Confusion
Many tax professionals misunderstand the three-of-five year rule. “I hear this misstated a lot as an activity can’t lose money for three or more years before it’s not deductible,” Jeremy says.
However, that’s not what the rule says. If an activity shows profit in any three of five consecutive years (or two of seven for horse-related activities), it creates a presumption of profit motive. This shifts the burden of proof from the taxpayer to the IRS, but it doesn’t guarantee anything.
“Even if the activity does meet that safe harbor presumption, the IRS can still determine that that activity is not engaged in for profit,” Jeremy warns. Conversely, “an activity can not have profits for more than three years and still be an activity engaged in for profit.”
Practical Lessons for Tax Professionals
Jeremy transforms Crile’s victory into actionable strategies for protecting clients:
- Document everything. “Documentation and record keeping is key,” Jeremy emphasizes. “Part of the reason Crile was successful is because she had a really good documentation system of her income, expenses, and all the work she produced and her efforts to market that work.”
- Understand your client’s industry. Jeremy notes how “understanding how the art industry works was key to this case.” Crile brought in expert witnesses to educate the court about art market dynamics. When you can explain why a business operates the way it does within its specific market context, losses become understandable business challenges rather than red flags.
- Focus on profit motive, not profit. “Having a profit motive isn’t the same as regularly making a profit,” Jeremy clarifies. Don’t scramble to show profitability. Focus documentation efforts on proving business intent.
- Get to know your clients. Jeremy urges practitioners to understand their clients’ business vision, market strategy, and operational challenges. This ensures “when they go through those periods of losses, you’ve got the ability to make a solid case for them that that activity is, in fact, still engaged in for profit.”
The Human Side of Tax Law
Jeremy finds Crile’s case particularly valuable because it shows “how technical rules and factors at play actually work out in a real life scenario.” Reading the court opinion alongside Crile’s post-case interview reveals “the human side of the story.”
The case made national headlines, with coverage suggesting it protected artists’ livelihoods by confirming their work could be businesslike. But as Jeremy notes, each case is different. “It’s entirely up to the taxpayer to conduct an activity in a professional and business-like manner to avoid the hobby loss rule.”
For tax professionals working with struggling entrepreneurs, such as artists, gig workers, or innovative startups, Crile’s case provides a masterclass in building defensible positions. The tax code, despite its complexity, can accommodate the messy reality of business development when practitioners know how to document and present their clients’ genuine business efforts.
Listen to Jeremy’s complete analysis of this landmark case in episode 16 of Tax in Action. If you work with small business owners, he strongly recommends reading the full Crile opinion to ensure your clients never face the devastating financial consequences of having their business reclassified as a hobby.