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The Music Mogul – a cautionary tale for hobby losses and undocumented expenses...


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6/3/2018
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The Music Mogul – a cautionary tale for hobby losses and undocumented business expenses…

In Cecile Barker v. Comm’r Internal Revenue, T.C. Memo 2018-67 (2018), a recording mogul aspiring to past glory in the music business had $1,807,887 of losses from his record label SoBe Entertainment International LLC disallowed by the IRS between 2003 and 2011.

Cecile Barker, an aerospace engineer, got involved in the music business in the 1960s and founded “Peaches & Herb” reaching the pinnacle in 1973, when he coproduced the Grammy-winning song “Midnight Train to Georgia” by Gladys Knight & the Pips.  Shortly thereafter, he went back to aerospace engineering and spent the remainder of his career running a successful aerospace engineering company, which he sold in 2001.

Between 2003 and 2011, Cecile Barker used his substantial resources to form and promote his record label SoBe Entertainment International LLC.  His son Yannique and daughter Angelique had a 5% interest in the partnership.

As part of his preparation to make the label a success, Cecile retained the services of several high-profile producers--such as Scott Storch, Pharrell Williams, Swizz Beatz, and Timbaland--to bolster SoBe’s chances of success.  The label signed several artists including petitioner’s son, Brooke Hogan, Paul Wight (“The Big Show”), and Wyclef Jean protégé Phyllisia Ross to name a few.  The label also entered into a joint venture with Universal Music to distribute music digitally.

Between 2003-2011, SoBe was a colossal failure, stacking up total losses of $37,764,787.  Cecile, who no doubt had a very successful career and made a lot of money, made contributions during this time totaling a whopping $45,339,138.

The IRS examined Cecile’s 2011 tax return and determined a deficiency in the amount of $1,259,279 because they determined his business to be a “hobby” that never made any money and which was not entered into as a legitimate “trade or business” but merely as a vehicle to offset gains and dividends from “defense contracting work” Cecile engaged in for the majority of his income.  The IRS also argued that Cecile lacked the documentation to substantiate these expenses and that they should have been capitalized, not deducted.

Determining the existence of a trade or business “requires an examination of the facts in each case.” Higgins v. Commissioner, 312 U.S. 212, 217 (1941). In particular, respondent contends that petitioner did not have “the actual and honest objective of making a profit.” See Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), aff’d, 702 F.2d 1205 (D.C. Cir. 1983).

Section 1.183-2(b), Income Tax Regs., provides nine nonexclusive factors to take into account in determining whether a profit motive exists: (1) the manner in which the taxpayer carries on his activity; (2) the expertise of the taxpayer and his advisors; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) whether the assets used in the activity are expected to appreciate in value; (5) the success of the taxpayer in carrying on 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 extent to which the taxpayer derives personal pleasure or enjoyment from the activity. The court’s consideration is not limited to these factors and none of them is determinative.

In this case, the Tax Court found a profit motive, and that SoBe wasn’t merely a hobby, but did not find that sufficient back-up existed to substantiate the Net Operating Losses claimed and thus disallowed the deductions and sustained the 25% accuracy-related penalty attributable to the underreporting of tax.



Category: Tax Law


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