Wish You Were Here: Sotheby’s Institute of Art (CA) Conference, January 2015

by Jessica Newman*

On January 30 and 31, the Sotheby’s Institute of Art gathered attorneys and art professionals together in Los Angeles, California for their Art Law Conference entitled “The Practice of Law in the International Art World.” The two-day expansive agenda featured twelve modules and nearly forty speakers, including artist Shepard Fairey giving an inspired keynote speech. The Conference addressed a number of issues at the confluence of art and law, including authenticity, looting, collecting, restitution, investment, public art, the future of art, and the art market. Following is a brief write up of the most memorable topics:

1. Liability v. Leadership: Advising Arts Organizations

Melody Kanschat, Executive Director of the Getty Leadership Institute at Claremont Graduate University, chaired a panel entitled “Liability v. Leadership: Advising Arts Organizations,” which featured Stephen Clark (J. Paul Getty Trust), Fred Goldstein (Los Angeles County Museum of Art), David Galligan (Walker Art Center), and Eva Schieveld (Van Gogh Museum). As multidimensional institutions, museums face a myriad of issues that extend far beyond the world of art. The panel emphasized that general counsel should be a part of all senior management conversations and budget discussions. One common concern was the avoidance of conflicts of interest (both real and apparent), particularly when dealing with a board of trustees.

One question posed to the panel was whether a museum can invest in a company which is run by a member of the museum’s board. As with many legal questions, the answer is, “Yes, but…” Although some museums have a strict zero tolerance policy when it comes to such investments, it is possible to structure transactions in a manner that avoids direct conflicts of interest. In part, the soundness of such a transaction turns on who is making the decision. It is important to ensure that the transaction is done at arm’s length and that no one who will directly benefit is personally involved in the decision whether or not to invest. In addition, transparency and continued management play important roles in preventing conflicts from arising.

2. Restitution Panel

Jonathan Petropoulos moderated the Restitution Panel, which explored the continuing evolution of restitution claims. Although issues of restitution have been around for some time, they remain a major concern for purchasers, heirs, and museums alike. Lucian Simmons of Sotheby’s observed that investigation into potential restitution issues remains a steady part of his work even today. Accordingly, as Simon J.Frankel (Covington) reiterated, research into proper provenance is as important as ever, and several conference speakers strongly advocated title insurance. As for the future of the field, Lawrence M. Kaye (Herrick), identified Russia as the next potential hotspot for restitution claims if access to Russian archives and collections becomes a possibility.

3. Secured Transactions

The second day of the conference began with a panel on Secured Transactions, moderated by Franklin Boyd and featuring John Arena (Bank of America), Stephen D. Brodie (Feinstein), and Karen McManus (Jacqueline Silberman & Assocs. Inc.). Art as an alternative asset has become increasingly popular for wealthy investors looking to diversify their portfolios. Art can also be used as a financial tool without having to sell the works by using the art as collateral. However, this option is only open to a select number of collectors.

The target collector is one with at least $10 million in well-established works (i.e., Old Masters, Modern, etc.) which can be quickly and easily sold were such a sale to become necessary for the lender. These works are appraised and, from a collector’s perspective, title insurance is recommended. Additionally, art must be the “second way out” of the deal. In other words, the borrower must have demonstrated equity in other assets. For those who can meet these criteria, using art to finance loans can be an attractive option. The fact that the United States is the only country where owners can maintain control of their collateralized works makes this option particularly appealing.

4. Art Collecting in the Current Legal Market

“Art Collecting in the Current Legal Market,” panel which was chaired by Mary Rozell (Sotheby’s) and featured Carol Bradford (California Community Foundation), Josh Roth (United Talent Agency, formerly Glaser Weil), and Katie Tolson (Gurr Johns). Although the increasingly global and technology-driven world of art collecting makes it easier than ever to access art, it also poses a number of challenges for the contemporary collector. For instance, documents can now be forged with the push of a button. However, one area in which technology has significantly enhanced the collecting experience is in inventory management. Ensuring proper documentation of one’s inventory is vital and a number of new software options have emerged that can assist a collector in doing just that. These software programs range in price, but at a minimum it should offer the collector a means of inputting photographs, descriptions of the works and details such as collection history, exhibition history, location, and inventory number. Ms. Tolson described her firm’s custom-designed Art Collection Management Software, which offers collectors a sophisticated means of managing their collections.

Roth discussed the increasing use of Section 1031 like-kind exchanges as a tool that can be utilized to expand one’s collection. Section 1031 of the Internal Revenue Code, entitled “Nonrecognition of gain or loss from exchanges solely in like kind,” provides a means for investors to defer taxes on capital gain from the sale of a work of art. In effect, 1031 Exchanges provide a collector with an interest-free loan from the government that can be used to subsidize future acquisitions so long as certain conditions are met. First, this section does not apply to personal property, as it applies only to property used for business or investment purposes. The exact parameters for this requirement are somewhat vague, however a work purchased solely for personal display in one’s home is not likely to qualify. Defining a like-kind property in this context can be equally difficult as there is no definitive guideline as to what type of art would be of like-kind to another. For instance, it is conceivable that the IRS may determine that a sculpture is not of like-kind to a painting.

Lastly, there are strict timing and designation requirements which are intended to distinguish a 1031 Exchange from a taxable transaction in which the purchaser merely uses the proceeds from a previous sale to purchase a new property. There are several ways to structure such an exchange, though the forward, or deferred exchange is most common. Broadly speaking a forward exchange works as follows: upon the sale of a work, the collector can use a 1031 exchange to defer the gain by investing the proceeds in a like-kind replacement property (i.e. another work of art) of equal or greater value. The replacement work must be identified within 45 days of the initial sale, and the collector has 135 days to close the sale upon identification. The appeal of such exchanges is evident, and Roth expects that they will only continue to grow in popularity.

Over the course of the two days, several takeaways emerged. First, many of the traditional issues within the field of art law – looting, restitution, importing/exporting, authenticity – remain at the heart of any art law practice. Secondly, the search for new uses and new means of valuing art has produced a number of creative options for investment and exchange of art. These options, however, are complex and require thorough due diligence by all parties. Lastly, the digital age has brought with it a host of new challenges for collectors, museums, artists, and attorneys alike. At the same time, technological advances also are opening up the art world in exciting ways.

Selected Sources:

About the Author: Jessica Newman is a third year dual-degree student pursuing a Juris Doctor and a Masters in Art History at Duke University. She can be reached at Jessica.newman@lawnet.duke.edu.

The European VAT: Good for Tax Revenue, Bad for the Commercial Art Market?

by Elizabeth R. Lash, Esq.

As an American, one might be forgiven for assuming that Europe, with its traditional support for the arts (at least, as a cultural phenomenon), would be equally supportive in its tax regime for the same. While in some limited instances, the European Union continues to provide a more favorable regime for the independent artist, the trend towards an ultimately higher value-added tax (“VAT”) on the sale, import and export of artwork, particularly with respect to art sold by galleries and in the resale market, may discourage the growth of an EU-wide commercial art market in comparison with more favorable tax regimes outside the EU.

VAT was initially intended to be used as a single tax rate applicable to all goods and services across all European Union member states. While the standard rate was originally set at 15% in 2006, member states could theoretically request reduced rates in one or two categories, set at no less than 5%. In reality, as each member state negotiated the terms of its entry into the EU, the list of categories has expanded to at least 21, with rates above and below the standard rates (which already varies from 17% to 27%), along with multiple categories of rates below 5% (zero rates, “parking rates” (i.e., rates negotiated with entry into the EU), and super reduced rates). As well, categories of rates are inconsistently drawn, from too narrow to overly broad: it includes, among others, such categories as printed books, e-books, cultural institutions, household cleaning, sporting facility use, bicycles, and writers and composers.

When it comes to artwork, VAT rates vary widely, ranging from 5% (Malta) to 25% (Sweden) (although there is a reduced rate for independent artists’ sales). In addition, VAT may be calculated on the margin (i.e., the difference between the original sale price and the purchase price), instead of under the standard or reduced rate (whichever is applicable to artwork in that particular member state). In a number of member states, the VAT may be set at multiple rates: one for independent artists; another for galleries and dealers; and still another for the import or export of art.

Further complicating this picture, the EU Commission may not only pressure (or even sue) a member state as to the categories for which reduced rates are permitted, but may also regulate individual tax cases affecting artists and collectors. One example in particular is the Flavin case, whose outcome confounded the international art community (and sets an unfavorable precedent in future, similar circumstances). In 2006, a British gallery (named the “Haunch of Venison”) imported two well-known American conceptual artists’ sculptures: Dan Flavin’s light sculpture, and Bill Viola’s video installations. The former consisted of several tubes of fluorescent lights, while the latter consisted of several audio-visual productions playing on various projection screens. The British customs office imposed a 20% rate instead of the reduced 5% rate for artwork. However, upon appeal to the British VAT and Duties Tribunal (the “Tribunal”), the reduced rate was re-instituted in 2008.

But despite this local regulator’s final decision (with no further appeal by the parties to the EU courts), the EU Commission weighed in anyway with its own regulation, issued in September 2010, which specifically overturned the Tribunal’s decision, ostensibly to effectuate the uniform taxation rules on imported goods. The EU Commission found that it was not the installations themselves which constituted artwork, but the results of such installations, whether of the “light effect” of Dan Flavin’s light sculpture, or the videos screened on Bill Viola’s video installations. Thus, in effect, the EU Commission found that the installations should have been taxed just as if a hardware or electronics store had imported lightbulbs and video components. For conceptual artists, this represented a major blow to the sale in and import of their artwork into Europe.

Then take Germany. Germany formerly assessed a reduced VAT of 7% on sales of art (other than photography). However, due to pressure from the EU Commission, which had opened proceedings against Germany regarding this reduced rate category, Germany passed legislation to raise the rate to 19%, effective January 1, 2014 (Germany’s standard VAT rate since 2007). In response, German federal legislators passed a national directive that permitted the tax to be assessed on only 30% of the purchase price, relying in part on an exception to the VAT directive that had been used in France for several years. But the application of this directive was restricted less than a year later by the German states to artwork priced under 500 Euros, and a few other categories, essentially undercutting the law’s essential purpose—to provide a more favorable rate for the commercial art market. Meanwhile, artists selling out of their studios remain subject to the 7% rate. While this may be acceptable for those select artists who sell out of their own studios, it does not bode well for those who are represented by galleries.

In 2014, in another instance of muddying the tax waters, the French government increased VAT on the sale of art in France from 7% to 10%, while still permitting imports of non-EU artwork to be taxed at 5.5%. Only a year later, the French legislators acknowledged this inconsistency, and reduced the VAT on direct sales by French artists to 5.5%, effective January 1, 2015. Meanwhile, in Spain, the current VAT on artwork was raised from 8% to 21% in September 2012, initially as part of the general rate assessed on goods and services related to “culture.” Within a year, after much hue and outcry, Spain decreased the rate again to 10%. Meanwhile, in Italy, the VAT on the sale and import of artwork is still 22%.

The dust may eventually settle on the various VAT rates and their application, but the newest wrinkle is a regulation (Council Implementing Regulation (EU) No 1042/2013) which changes how VAT is assessed—from the place of supply to the place of purchase. While this does not affect traditional visual artists and sculptors, it does impact those who are considered to supply services or goods digitally to consumers—for instance, freelance website designers. The regulation, effective January 1, 2015, requires such businesses to assess VAT based on the country of the purchaser, rather than the VAT of their own country, placing yet another burden on artists in figuring out the application of VAT—even though the regulation was meant, in part, to apply to the likes of e-retailers such as Amazon.com.

In light of the fluctuations in tax rates and their applications, with the ultimate trend inching towards a uniformly high VAT rate, the art market looks nowhere near as enticing in the EU as it does in those countries and locales not subject to the vagaries of the VAT rate debate. In the U.S., for instance, no VAT exists (although, of course, the U.S. does have a sales tax), and there is no import duty assessed on original works of art. Hong Kong does even better—it has no sales tax, import tax, or export tax on artwork. To some degree, the numbers back this up: according to an annual study conducted by Arts Economics for the European Fine Art Foundation, in 2013, the U.S. accounted for 38% of the global market by value, while the EU as a whole dropped 3% points to 32%. (The UK ranked separately at 20%–perhaps not a surprise in light of its 5% reduced VAT rate on artwork, the Flavin case notwithstanding.) Moreover, in the EU itself, the numbers for those member states with the highest VATs declined or remained the same. And while Hong Kong and Singapore did not rank individually as the top winners in 2013 (having perhaps to do with factors other than VAT or customs duties), still, such figures may show in part the effect of applicable tax regimes.

Then there are the so-called “free ports,” located around the globe, which have become popular as a way to store works of art intended primarily as an investment. A free port is essentially a tax haven: artwork may be shipped directly to the free port, and as long it is stored there, VAT will not be assessed on the import. (Of course, once the work is shipped outside the free port to its new destination, any applicable tax will be assessed.) An additional benefit for potential purchasers (depending on the local laws applicable to the free port) is that VAT may not be assessed on any sales of artwork made within the free port—at least not until the artwork has left the free port. (So, hypothetically speaking, if a sale has been made, but the work never leaves the free port, VAT will never be assessed.) Arguably, the art fair Art Basel became popular just for that reason, having made its initial home base in a Swiss free port. As of right now, there are free ports located in Switzerland, Luxembourg, Singapore, and Beijing. (One of the best indications of how popular the Singapore free port has become is that Christie’s auction house now has an office located there.)

The EU Commission has previously expressed that VAT rates are not to be used to control social and economic policy in the EU, and clearly is increasingly attempting to pressure member states, whether through regulation, litigation, or other alternative avenues, to raise VAT rates to a uniformly high rate. However, in the face of global competition, one can only wonder what this trend may mean for the EU in the future as a major player in the commercial art markets.

 

Sources:

About the Author: Elizabeth R. Lash, Esq., serves as in-house counsel at Kroll, where she focuses on reviewing agreements relating to cyber security and data breach notification.

DISCLAIMER: This article was prepared by Ms. Lash in her personal capacity; the opinions are the author’s own, and do not reflect the view of Kroll Associates, Inc. or of its affiliates.

Case Review: Crile v. Commission of Internal Revenue

By Chris Michaels, Esq.*

“All children are artists. The problem is how to remain an artist once he grows up.” – Pablo Picasso

For many artists, the financial instability that accompanies an artistic profession forces the artist to seek employment with a more consistent paycheck. A “day job” often provides the income for rent and bills while the artist continues to pursue their artistic endeavors. In this situation, tax deductions for expenses related to creating art may help the artist stay afloat financially. It seems like a fairly straightforward situation until April 15 rolls around and it is time to pay taxes. In a ruling filed by the United States Tax Court on October 2, 2014, the Court resolved a question of whether individuals who pursue their art while otherwise employed can deduct art-related expenses. The decision the Court reached helps artists to remain artists, even if they are not making a profit from their work.

Susan Crile Website

Susan Crile Website

The petitioner in this case, Susan Crile, has worked as an artist for over four decades. She has created more than 2,000 works using oil, acrylic, charcoal, pastels, and many other mediums. Her art is in the permanent collections of several museums including the Metropolitan Museum of Art, the Guggenheim Museum, the Brooklyn Museum of Art, the Phillips Collection, and several colleges and universities. In addition, her work has been purchased by corporations including Bank of America, General Mills, Charles Schwab, and several major New York City law firms. She has been represented by at least five New York City art galleries, most recently in 2009 by the Michael Steinberg Fine Art gallery. She has received awards from the National Endowment for the Arts and her works have been reviewed in almost every major art publication. Crile is also a full-time tenured professor of studio art at Hunter College in New York City, where she has worked in some capacity since 1983.

The respondent in this case, the Commissioner of Internal Revenue, determined that Crile had deficiencies in her Federal income tax returns for the years 2004, 2005 and 2007–2009. Specifically, respondent argued, among other things, that Crile was not entitled to claim deductions for expenses related to her artwork because she did not intend to profit from her art. The Court, therefore, was faced with determining the issue of whether Crile was engaged in a trade or business with the intent of making a profit from her activity as an artist. Crile’s artwork during the tax years in dispute included a series of works based on the life of Saint Francis in the Basilica di San Francesco in Assisi, Italy, works based on the events at the Abu Ghraib prison in Iraq, silkscreen printings, a series of small abstract paintings, and a project based on the prisoners in Guantanamo Bay.

Since her art career began in 1971, Ms. Crile sold over 300 works with gross proceeds of $1,197,150 and an earned income of $667,902. From 1971 to 2013, however, she never reported a net profit from her art business due, in large part, to the deductions she took for expenses relating to the sale of her art.

To determine whether Crile was entitled to the deductions she had taken, the Court considered two sections of the Internal Revenue Code, sections 162(a) and 183(b). Under section 162(a), deductions are allowed for “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” To be entitled to deductions under section 162(a), the taxpayer must show that he or she engaged in the activity with the intent of making a profit. Further, under section 183(b), if the activity is not engaged in for profit, deductions are not allowed except to the extent of gross income derived therefrom. Essentially, in order to take the deductions, Crile had to prove that she was in the art business to make a profit.

A threshold issue that had to be decided before the Court reached the issue of Crile’s intent to earn a profit concerned the scope of her activity as an artist. Under section 183(b), the activity to be considered can either be a “single undertaking” or “multiple undertakings.” The Commissioner argued that Crile’s art activity was not separate from her activity as an art professor and was thus a “single activity.” As a single activity, the Commissioner posited that Crile had to claim her art-related expenses as unreimbursed employee business expenses and not as deductible business expenses. The Court ultimately reasoned, however, that she had practiced as an artist for a decade before she had started teaching and that many activities she undertook as an artist were unrelated to her teaching career. As such, the Court held that Crile’s artist activities and professor activities were multiple undertakings that had to be analyzed separately under section 183(b).

The bulk of the Opinion handed down by the Court dealt with whether the artist conducted her art activity with an intent to earn a profit such that she could take deductions for expenses attributable to that activity. The Court analyzed the following nine factors and used a balancing test to determine whether Crile engaged in the activity for profit:

  1. The manner in which the taxpayer conducts the activity;
  2. The expertise of the taxpayer or her advisers;
  3. The time and effort spent by the taxpayer in carrying on the activity;
  4. The expectation of the taxpayer that assets used in the activity may appreciate in value;
  5. The success of the taxpayer 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;
  8. The financial status of the taxpayer; and
  9. Elements of personal pleasure or recreation.

An analysis by the Court concluded that factors number one through five and nine were in favor of Crile and factors six and seven were in favor of the Commissioner. Factor number eight was neutral. As such, the Court held that Crile acted with the requisite intent to make a profit and, therefore, could take deductions for “ordinary and necessary expenses.” The Court reserved deciding on whether the deductions that Crile took were actually “ordinary and necessary.”

The Court’s decision in this case is a win for struggling artists everywhere. In finding that Crile engaged in her art activity as a distinct activity from her employment as a professor, the Court gave artists the opportunity to take deductions for expenses relating to their artwork as long as they are engaged in that activity for profit. While it certainly is not a windfall for anyone, the Court’s decision makes it a little easier for grown ups to remain artists.

Petitioner, Susan Crile, was represented by Robert H. Baron, Micaela McMurrough, and Megan Y. Lew, all of Cravath Swaine & Moore LLP. Respondent, Commissioner of Internal Revenue, was represented by Jane J. Kim and Michael J. De Matos of the Internal Revenue Service.

Sources:

About: Chris Michaels is a litigation attorney in the Philadelphia office of the Atlanta, GA-based law firm, Cruser & Mitchell, LLP, where he actively pursues his interest in the field of art law. He may be reached at (518) 421-7238, chriswmichaels@gmail.com, or on Twitter @CMichaelsartlaw.

Disclaimer: This article is intended as general information, not legal advice, and is no substitute for seeking representation.

Art Law Visiting the Non-profit Side: On Qualifying for 501(c)(3) Status as an Arts Organization

By Benjamin Takis*

2014-05-25 collage

Background

New non-profit organizations often find that the world is not a hospitable place. While innovation, entrepreneurship, and risk-taking by new for-profit companies are lauded, fledgling non-profits typically struggle to gain the acceptance and support of private foundations, donors and others in the non-profit community. There is, after all, only a limited supply of grants and donations to fund charitable, artistic, and educational endeavors. Furthermore, the administrative burden of forming and administering a non-profit can be staggering. New non-profits are therefore often advised to pair up with an existing organization, use a for-profit structure, or explore other alternatives before forming a new entity and applying to qualify under section 501(c)(3) of the Internal Revenue Code (the “Code”).

Despite these challenges, arts organizations share certain traits that can help them thrive as non-profit 501(c)(3) organizations, with fewer of the hurdles faced by other kinds of non-profits. First, while many organizations rely largely on foundation grants and private donations, arts organizations can raise funds from ticket sales to performances, exhibits, and other events. For many kinds of organizations, these “fee-for-service” revenue sources can trigger “unrelated business income tax” or endanger 501(c)(3) status under the “commerciality doctrine” applied by the Internal Revenue Service (“IRS”) and the courts. However, these revenue sources are generally consistent with the tax-exempt status of arts organizations. Additionally, these types of revenue sources can more easily satisfy the “public support” tests that enable an organization to qualify as a public charity, and thereby avoid classification as a private foundation and the stringent oversight to which private foundations are subjected.

The Benefits and Burdens of 501(c)(3) Status

501(c)(3) is a special tax status under federal law, generally available to organizations formed and operated for a charitable, educational, scientific or religious purpose, and promotion of the arts is recognized as a valid educational purpose. Treas. Reg. § 1.501(c)(3)-1(d)(3)(ii), Example 4 (Educational organizations include “[m]useums, zoos, planetariums, symphony orchestras, and other similar organizations,” provided that the organizations otherwise satisfy the requirements of section 501(c)(3) of the Code). However, before embarking on the 501(c)(3) qualification process, it is important to carefully consider whether the benefits of 501(c)(3) status are worth the burdens.

There are three legal benefits to having 501(c)(3) status: (1) the organization’s net revenue (after expenses) is generally not subject to tax; (2) contributions to the organization are eligible for the charitable deduction; and (3) the organization is eligible for grants from private foundations.

These benefits are not quite as advantageous as they may appear. Most non-profits (including arts organizations) do not have large amounts of excess revenue – most struggle to earn enough revenue to pay their expenses. Therefore, the tax exemption on net revenue may not be crucial. Second, while the charitable deduction is a powerful incentive for individuals inclined to give money to non-profit organizations, it is still a difficult task to convince people to give. The charitable deduction tends to be important only when an organization’s Board of Directors has a strong and committed network of high-wealth individuals. Lastly, it can be difficult to get grants from private foundations. Finding grant opportunities takes significant research, and the grant writing process requires preparation, perseverance, and commitment.

Maintaining 501(c)(3) status can also be quite burdensome. A 501(c)(3) organization must be run by a Board of Directors (generally 3 or more people) in accordance with Articles of Incorporation, Bylaws, and various corporate policies that comply with requirements set forth under federal tax law and state non-profit corporation law. In addition, any compensation to Directors or Officers must be closely scrutinized to ensure that such payments are reasonable. And complex tax filings called the Form 990 (or Form 990-EZ) are generally required for organizations with gross revenue exceeding $50,000 per year, and are open to public inspection. (Organizations whose annual gross receipts are normally $50,000 or less, file a much simpler electronic form called the Form 990-N). These and other administrative difficulties are not typically worth the trouble unless 501(c)(3) status would significantly enhance an organization’s fundraising capabilities, or at least its image in the arts community.

Designing a Program of Activities to Qualify under 501(c)(3)

An arts organization that has thoroughly considered the benefits and burdens of 501(c)(3) status and wishes to move forward with the qualification process will need to design a program of activities consistent with 501(c)(3) status. It is important to be aware of which types of activities are acceptable and which activities raise suspicions at the IRS, and be able to show the IRS several bona fide activities that fit squarely within the traditional notions of a 501(c)(3) arts organization.

The exemption under section 501(c)(3) for arts organizations is based on the statutory exemption for “educational” organizations, so educational activities carry significant weight in the approval of 501(c)(3) status. Examples of educational arts organizations include:

  • An organization formed to promote the advancement of young musical artists by conducting weekly workshops, and sponsoring public concerts by the artists. Rev. Rul. 67-392, 1967-2 C.B. 191.
  • An organization formed to promote public appreciation of group harmony singing by holding frequent meetings of members where they receive training and instruction in vocal harmony and opportunities to practice under trained supervision. Rev. Rul. 66-46, 1966-1 C.B. 133.
  • A dance school with a regular faculty, daily comprehensive curriculum, and a regularly enrolled body of students. Rev. Rul. 65-270, 1965-2 C.B. 160.

Educational activities can also include individual instruction, or the dissemination of instructional materials for free or for a nominal charge. See Rev. Rul. 68-71, 1968-1 C.B. 249 (approving the 501(c)(3) status of an organization that provided career education by distributing educational publications at a nominal charge and providing free vocational counseling services).

Public exhibits or performances are also typically valid 501(c)(3) activities, provided that steps are taken to ensure that the selection of artists is disinterested (i.e. the organization is not merely a vehicle for showing the work of founders, directors or other insiders of the organization), and provided that the artists or works are chosen for their artistic merit rather than their ability to appeal to a mass audience. See Plumstead Theatre Soc’y, Inc. v. Comm’r, 74 T.C. 1324, 1332-1333 (1980), aff’d 675 F.2d 244 (9th Cir. 1982) (contrasting commercial theaters, which “choose plays having the greatest mass audience appeal … run the plays so long as they can attract a crowd …[and] … set ticket prices to pay the total costs of production and to return a profit,” with 501(c)(3) theaters, which “fulfill their artistic and community obligations by focusing on the highest possible standards of performance; by serving the community broadly; by developing new and original works; and by providing educational programs and opportunities for new talent.”). It helps if at least some of these exhibits or performances are open to the public for free.

For example, the IRS has approved the 501(c)(3) status of the following organizations:

  • An organization whose sole activity was sponsoring an annual art exhibit of artists selected by a panel of qualified art experts. Rev. Rul. 66-178, 1966-1 C.B. 138.
  • A filmmaking organization that organized annual festivals to provide unknown independent filmmakers with opportunities to display their films. Rev. Rul. 75-471, 1975-2 C.B. 207.
  • An organization that presented public jazz concerts featuring aspiring jazz composers and high school students performing alongside established jazz musicians. Rev. Rul. 65-271, 1965-2 C.B. 161.
  • A touring repertory theatre company that focused on works that were part of college curricula. Rev. Rul. 64-175, 1964-1 C.B. 185.

Note that the IRS views the exhibition of art much differently than the sale of art, especially with respect to the visual arts. The IRS typically denies 501(c)(3) status to art galleries that engage in the sale of art for a commission. See Rev. Rul. 76-152, 1976-1 CB 151 (rejecting the 501(c)(3) status of a gallery formed to promote modern art trends by exhibiting works of modern artists and selling the works on consignment basis with the artist setting the selling price and the organization keeping a 10% commission, even though this commission was lower than that charged by commercial entities and the gallery planned to supplement its revenue through donations); Rev. Rul. 71-395, 1971-2 CB 228 (rejecting the 501(c)(3) status of a gallery formed and operated by approximately 50 artists for the purpose of exhibiting and selling the work of the founders).

Gallery sales activities are permitted only under very limited circumstances when sales activities are sufficiently minor in comparison to educational and other valid 501(c)(3) activities. Goldsboro Art League, Inc. v. Comm’r, 75 T.C. 337 (1980) (approving the 501(c)(3) status of a gallery that engaged in some sales for commissions in addition to educational activities, based on the following factors: (1) there were no other museums or galleries in the area, thus, the exhibition of art works showed a purpose primarily to educate rather than to sell and the selling activity served merely as an incentive to attract artists to exhibit their work; (2) works were selected by an independent jury for their representation of modern trends rather than salability; (3) the organization demonstrated that educational activities were its priority; (4) the art sales were not conducted at a profit; and (5) of more than 100 works of arts exhibited in the organization’s galleries, only 2 members of the organization had their art exhibited).

Most 501(c)(3) arts organizations focus predominantly on education and/or public exhibits or performances, but other types of activities can be acceptable as well. For example, the awarding of grants to aspiring artists and students is a permissible 501(c)(3) activity, provided that procedures ensuring disinterested selection of winners are developed and scrupulously followed. See Rev. Rul. 66-103, 1966-1 C.B. 134 (approving the 501(c)(3) status of organization formed for the purpose of making grants available to writers, composers, painters, sculptors, and scholars for projects in their respective fields which they would not otherwise be able to undertake or finish due to the lack of funds. In awarding grants, preference was given to persons showing distinction or promise in their respective fields, and the recipients promised to make their work available for the benefit of the public in ways customary and appropriate to the particular work. The organization received no financial benefit from these grants).

The IRS has also approved of activities promoting the appreciation of art by less traditional means, such as the recording and sale of obscure classical music pieces to educational institutions, Rev. Rul. 79-369, 1979-2 C.B. 226, and a museum’s sale of greeting cards displaying printed reproductions of selected works from the museum’s collection and from other art collections. Rev. Rul. 73-104, 1973-1 C.B. 263. However, these types of non-traditional promotional activities should be approached with caution, as they implicate difficult issues that can lead to unpredictable results from the IRS. See e.g. Rev. Rul. 76-206, 1976-1 C.B. 154 (rejecting the 501(c)(3) status of an organization formed to generate community interest in classical music by urging the public to support the classical music program of a for-profit radio station).

In summary, when applying for 501(c)(3) status, an arts organization should be prepared to describe several activities similar to those approved by the IRS. There should be at least some educational component, whether through workshops, classes, online publications or tutorials, or other means. It is helpful to show engagement with the public or local community through free exhibits or performances, and to focus on art that lacks mainstream commercial viability. Lastly, an organization founded or run by artists should make sure to focus on a wide variety of artists rather than just its founders or members.

About the Author: Benjamin Takis is the founder and principal attorney of Tax-Exempt Solutions, PLLC. He may be reached at btakis@taxexemptsolutions.com.

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