Get Lost in Your Own Museum
If you have a large collection of anything, it possible to form your own museum and organize the museum as a non-profit and permit federal tax deductions for donations to the museum.
IRC Section 4942(j)(3) allows for the organization of private operating foundations. Operating charitable foundations are distinct from non-operating charitable foundations in that they actively run and manage charitable operations as opposed to just distributing grants. These organizational structures are defined by the code as any organization (as defined by the section) which makes qualifying distributions directly for the active conduct of the activities constituting the purpose or function for which it is organized and operated equal to substantially all of the lesser of its adjusted net income (as defined in subsection (f) of the section), or (ii) its minimum investment return.
To be clear, 26 CFR § 53.4942(b)-1 defines “substantially all” as 85% or more.
IRC Section 4942(j)(3) also requires:
Substantially more than half (65%, under 26 C.F.R. § 53.4942(b)-2(a)(5)) of the assets of which are devoted directly to such activities or to functionally related businesses (as defined in paragraph (4)), or to both, or are stock of a corporation which is controlled by the foundation and substantially all of the assets of which are so devoted
Qualifying distributions directly for the active conduct of the activities constituting the purpose or function for which it is organized and operated are in an amount not less than two-thirds of its minimum investment return.
Substantially all (85%) of the support is received from the general public and from 5 or more exempt organizations; not more than 25 percent of the support (other than gross investment income) of which is normally received from any one such exempt organization; and not more than half of the support of which is normally received from gross investment income.
26 CFR § 53.4942(b)-3 requires that a foundation must satisfy these requirement for any 3 taxable years during a 4-year period consisting of the taxable year in question and the three immediately preceding taxable years or on the basis of an aggregation of all pertinent amounts of income or assets held, received, or distributed during such 4-year period.
Selling out Without Selling out: The Art of Tax Exempt Commerce
Can a museum or gallery engage in commerce and remain a non-profit? It depends!
An organization may engage in a trade or business as long as its operation furthers an exempt purpose and its primary objective is not the production of profits. see Goldsboro Art League, Inc. v. Commissioner, 75 T.C. 337, 343 (1980). In Goldsboro Art League, Inc., the league sold artwork (in addition to holding educational classes and exhibiting work) and retained a portion of the sale as a commission but maintain non-profit status because the court found incidental to its other activities and serve the same overall objective of art education. This is not a case where the other activities are adjunct to petitioner's sales, but, rather, where petitioner's sales activities are secondary and incidental to furthering its exempt purpose. Id.
Treasury Regulation § 1.501(c)(3)-1(e). It states “An organization may meet the requirements of section 501(c)(3) although it operates a trade or business as a substantial part of its activities, if the operation of such trade or business is in furtherance of the organization’s exempt purpose or purposes and if the organization is not organized or operated for the primary purpose of carrying on an unrelated trade or business, as defined in section 513” The Regulation goes on to explain that when evaluating what constitutes the “primary purpose”, “all the circumstances must be considered, including the size and extent of the trade or business and the size and extent of the activities which are in furtherance of one or more exempt purposes” 26 CFR § 1.501(c)(3)-1(c)(1) states “An organization will not be so regarded [as a non-profit] if more than an insubstantial part of its activities is not in furtherance of an exempt purpose”
IRS Rev. Rul. 71-395 held that that a cooperative art gallery formed and operated by a group of artists to exhibit and sell their own works does not qualify for tax-exempt status under IRC Section 501(c)(3)
Rev. Rul. 76-152 held that a nonprofit which exhibited and sold art for local artists and retained a ten percent commission did not qualify for exemption because the direct benefit to the artists could not be considered incidental.
Non-Profits can be liable for federal income tax from a trade or business that is regularly carried on, but is not substantially related to the purpose that forms the basis for their income tax exemption. See IRC 511-514.
What should you do if you are a non-profit and municipality (or the federal government) is trying to revoke your status based on the trade or businesses your organization is carrying on ? You should marshal the facts on how the trade or business is incidental to furthering your exempt purpose. Since municipalities sometimes follow the Federal Government’s lead and often find their positions persuasive, you should understand that revenue rulings, treasury regulations and Tax Court decisions often contradict one another. If the municipality cite a Rev. Rule for the proposition of revoking your non-profit status, there is probably a treasury regulation or Tax Court case that says the opposite.
Search if your work is in datasets that could have been used to train an LLM
The Atlantic has published a tool which allows artists and writers to search if their work is in datasets. They clarify that just because a work is in a dataset doesn’t necessarily mean that it was used to train an LLM . They also clarify that they don’t have every single dataset used to train AI and thus if you don’t see your work listed it doesn’t mean that it wasn’t used to train an LLM.
A-Corp OK for you?
Colorado recently passed the Colorado Artist Company Act which created a new type of corporation for artists to organize themselves into a business. They are referred to as A-Corp and if it finds success in Colorado other states may adopt similar forms to help their own artists in the same way.
Key aspects of the law are as follows:
Artists must own 51% of voting shares. This is set by statue and cannot be contracted away.
Intellectual Property transferred to the corporation cannot be transferred to a non-artist investor or 3rd party. If the corporation is dissolved, the Intellectual Property reverts back to the artist who created it. In Waite v. UMG Recordings, Inc. (2020) a group of musicians tried file termination claims (demanding their intellectual property back) under 203 of the copyright act and UMG denied those claims under the reasoning that the artists had assign those intellectual property rights to carve out corporations. If those corporations had this protection afford to A-Corporations, this would not have happened.
Economic governance can be separated from artistic control. Artists can give non-artist investors rights of economic distribution or royalties while retaining complete creative control over the creation of their art.
Members and Managers have fiduciary duty to preserve the artists mission while balancing it with financial interests.
Gain Today, Gone Tomorrow: Installment Sales and Other Ways to Avoid Gains
At various points collectors or gallery owners will want to turn over their art work or collectibles and acquire new pieces. If a piece is sold, it may subject a tax payer to paying taxes on capital gains (or claiming a loss). IRS Revenue Code section 1031 used to allow for the deferral of paying taxes on a capital gain (or loss) at the disposal of property if it is exchanged for a “like-kind'“ property. This used to apply to personal property, which would include artwork. However, the Tax Cuts and Jobs Act (TCJA) of 2017 eliminated this avenue for collectors and gallery owners.
There are some alternative strategies that can be used to avoid realizing a gain (or loss) all at once. First, a collector or gallery owner can use an installment sale under Internal Revenue Code 453. Instead of receiving complete payments all at once, you receive payments over time. The IRS requires a taxpayer to characterize portions of each payment as return of basis (tax free), capital gain (capital gains tax) , and interest (ordinary income tax) on the remaining balance. It is best to consult a licensed professional in order to construct and report the installment sale correctly. This cannot be used for inventory. Thus, gallery owners can use this to dispose of works that they display, but not sell.
The obvious downside to using this strategy is is that collector or gallery owner is not paid all at once. The benefit to using it is that it will allow them to stay in a lower bracket while earning even more money over time. The Net Investment Income Tax applies to individuals that earn more than $200,000. Utilizing an installment sale might allow some collectors and gallery owners to avoid this. Obviously, this strategy should only be used with buyers that collectors and gallery owners trust to follow through on all the payments.
Second, for very large capital gains collectors or gallery owners it might make sense to place the proceeds from a sale into a quailed opportunity fund. Under the TCJA qualified opportunity funds are specific funds which invest in specifically economically distressed areas in the country. Profits invested in these funds become completely tax free after 10 years (if the funds invested are withdrawn earlier a percentage of capital gains tax will be due).