Part 1. Tax Considerations Relevant to Gifts
A. The Tax Status of the Donee Museum
B. Income Tax Consequences of Charitable Gifts to “Publicly Supported” Museums
D. Spreading Out Charitable Deductions
F. Premiums or Benefits Associated with Gifts and Substantiation of Gifts
G. The Museum’s Position on Donor Deductions
Part 2. Tax Considerations Relative to Audit Purposes
B. Museum Response to FASB and GASB
No member of a museum’s staff should attempt to play the role of a tax adviser to donors or prospective donors. Nevertheless, a general understanding of the tax consequences of charitable gifts is necessary if the museum expects to act intelligently and with integrity when matters of this nature are at issue.1 In some instances it is quite appropriate for the museum to suggest to a potential donor a possibly advantageous method of giving (with the understanding that the donor will pursue this with his or her own advisers), just as on some occasions a museum should give a firm “No, thank you” to certain offers. Without some knowledge of the intricacies of the tax consequences of various gifts, a museum is hardly able to comport itself with any assurance. What follows, however, is only a basic outline of the most common gift situations and relevant federal tax law.2
In this discussion, it is assumed that the museum has requested and received a determination letter from the Internal Revenue Service (IRS) recognizing the museum as an exempt organization under § 501(c)(3) of the Internal Revenue Code.3 Section 501(c)(3) provides an exemption from federal income taxes for organizations that are formed and operated exclusively for charitable (including educational) purposes.4 If such organizations also can demonstrate that they receive a substantial part of their support from governmental units or from the general public, they qualify as “publicly supported” charities.5 Under § 170(c) of the code, donors to such publicly supported charities receive the maximum possible deductions for their charitable contributions.
As a general rule, a charitable contribution must be reported in the year it is completed and at its full value. In addition, a donor is limited in the total amount of charitable contributions that can be deducted in any one year. The limit is a percentage of the donor’s “adjusted gross income,” as that term is defined in the Internal Revenue Code, and the limits differ depending on the type of property at issue, the time period that the donor owned the property, and the way the property is valued. The totals that an individual donor can deduct each year are, therefore, unique to his or her situation; thus, applicable rules are not discussed here. However, what is of interest to a donee organization is that even though these limits exist, a donor can legitimately “carry over” to future tax years major charitable donations that exceed the permissible limits in the current year. More is said about this in this chapter’s Section D, “Spreading Out Charitable Deductions.”
Regarding the “value” placed on gifts to charitable organizations, the following basic rules should be kept in mind.
Cash. For purposes of a charitable contribution deduction, a gift of cash is valued at its dollar amount. There is an exception to this rule, however, when the donor could receive or does receive goods or services in return for the gift. This exception is explained in this chapter’s Section F, “Premiums or Benefits Associated with Gifts and Substantiation of Gifts.”
Capital Gain Property. Capital gain property is property that is held by the donor usually for more than one year (but consult current law, since the time period can vary) and that, if sold at fair market value on the date of contribution, would result in long-term capital gain.6 Most gifts of tangible personal property that are given to museums qualify as capital assets and, as a rule, can be valued at their “fair market value” for charitable contribution purposes. Fair market value is defined by the IRS as “the price that property would sell for on the open market. It is the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts.”7 However, there are some exceptions to the general rule of valuing gifts of capital assets at fair market value. One concerns restrictions that may have been placed on the gift. If the restrictions are such that they would impact on “fair market value,” as that term is defined, then the value placed on the gift has to reflect these restrictions.8 Another exception, the unrelated use exception (see this chapter’s Section C, “Concept of ‘Unrelated Use,’ ”), frequently applies to museums. A fair market value deduction for a gift of capital gain property is allowed only if the property will be used by the museum for a purpose “related to” its educational purposes.9
Ordinary Income Property. Ordinary income property is property that, if sold at fair market value on the date of contribution, would result in ordinary income or in short-term capital gain. The value of a gift of ordinary income property for purposes of the charitable deduction is the fair market value of the gift less the amount that would be ordinary income or short-term capital gain if the property was sold for the fair market value. In essence, this amounts to what the donor actually paid for the property. Examples of ordinary income property most frequently donated to museums include works of art created by the donor, manuscripts prepared by the donor, and capital gain property held by the donor for less than the period prescribed for long-term capital gain.10
As defined by the IRS, the term “unrelated use” is a “use which is unrelated to the purpose or function constituting the basis of the charitable organization’s exemption under § 501 of the Internal Revenue Code.”11 Clearly, therefore, an object accepted for a museum’s collections or for use in one of its educational activities is designated for a related use, and the donor is entitled to a charitable contribution deduction at the fair market value. Similarly, if furnishings are contributed to a museum and are used by it in its offices and buildings in the course of carrying out its functions, this is a related use. However, if the museum intends to sell the donated objects—even though the proceeds of the sale are to be used to purchase objects for the collections—this is considered an unrelated use. If tangible personal property is given for an unrelated use, the donor’s allowable deduction is substantially changed. In this case, the donor’s allowable deduction is limited to the fair market value reduced by any amount that would have been long-term capital gain if the donor had sold the property for its fair market value. In other words, the tax consequences for a donor are usually much less favorable when the gift will be put to an “unrelated use” by the donee organization. The museum has a responsibility to inform the donor if it does not intend to use the offered property for a related use, so that the donor is not misled as to tax consequences. In addition, if the gift is valued at more than $5,000 and the museum completes an IRS Form 8283 for the donor (see this chapter’s Section F, “Premiums or Benefits Associated with Gifts and Substantiation of Gifts”), the museum must indicate on the form whether it intends to use the property for an unrelated use. Museum records should show that this information was conveyed.12
One question is often asked by museum people: In order to avoid an unrelated use situation, how long must the museum hold a donated object before selling it? The only reasonable answer is that no object should be accepted as a “related use object” unless there is a good-faith intention at that time to put it to a related use for the indefinite future. In effect, the integrity of the individual empowered to accept the object and the museum’s integrity are at stake. Within a year, five years, or ten years, certain circumstances could make the sale of that object appropriate, but the records of the organization will confirm whether the original acceptance was made in good faith or not. Put another way, every museum is supposed to keep accurate records of when each object is accessioned and also of why and when, if ever, it is disposed of. If there is a pattern of “in, hold for a period, and out,” or if the records do not support the reasons given for disposal (more important gifts received in this area or a change in the overall focus of collecting, for example), then the integrity of the accepting authority is in question. Simply put, if staff members are aware of the IRS guidelines on “unrelated use” and if the rule in the museum is that meticulous collection records are to be maintained, serious problems in this area should not occur.13
Another frequent question concerns the appropriate handling of a group or collection of objects offered to a museum when probably only a portion of the objects will prove suitable for the collections. Assuming that the museum can justify accepting the entire offering, does the fact that some of it will not be put to a related use jeopardize the status of the entire gift? IRS regulations [See 14.26 R. 1.170 A 4 (b) 3] contain the following statement: “If a set or collection of items of tangible personal property is contributed to a charitable organization or governmental unit, the use of the set or collection is not an unrelated use if the donee sells or otherwise disposes of only an insubstantial portion of the set or collection.” Whether “insubstantial portion” refers to quantity, quality, or dollar value is not clear, but a commonsense decision by the museum based on the particular situation should not be so far off the mark as to cause concern.
Although there is a limit to the amount of charitable deductions a donor can claim in a year, there is also a five-year carryover period. If a donor’s allowable deductions for charitable gifts in one year exceed the permissible limits, based on his or her adjusted gross income for that year, the donor may deduct the excess in each of the five succeeding years until it is used up. Thus, a donor, in effect, has six years in which to absorb the tax benefit of a substantial gift to charity.
Still, the six-year period may not be enough to take the full tax advantage of a major gift. In such cases, a fractional gift (also known as a partial gift) might be considered. In a fractional gift situation, the donor gives the museum ownership in a portion of the property, with the understanding that the remaining portion(s) will be given at a later date. Also, under this arrangement the donee organization has the right to possess the gift periodically for a length of time commensurate with the portion of the title it currently holds. This particular form of giving was substantially altered by legislation in 2006 and 2007, and as of 2011 its ultimate configuration is still in doubt. As of 2011, museums and similar organizations are vigorously urging Congress to consider a number of amendments to the 2006 and 2007 legislation that, they argue, unnecessarily restrict what was once a popular form of gifting objects to charities. The problem may be more easily illustrated by example.
Suppose in 2005 Mrs. X had a very valuable collection of dolls and she wanted to give the collection to the local historical society. In her tax bracket, however, six years would be insufficient time for her to use up the allowable charitable deduction. However, under the law at that time, she could immediately give the historical society an undivided one-half interest in the collection, with the understanding that six years later she would convey the remaining one-half interest. The entire collection could be turned over to the historical society, with Mrs. X’s one-half undivided interest held as a loan with an appropriate loan agreement in effect (an agreement that should allow her to recall the loan for half of the year at her option). Properly done, this arrangement would give Mrs. X twelve years to absorb the tax benefits of her gift. The subject of a fractional gift can be a single item or a group of items. Under the rules at that time, each fractional gift was valued at its fair market value at the time title to that fraction passed to the donee organization.
As mentioned, fractional gifts became a very popular method of giving objects or collections to museums, but, as so frequently happens, there were real or apparent abuses. For example, there was evidence that many who used this method of giving
• were not required to turn over their objects to the donee organizations for periodic use for the public,
• that frequently each time another fraction of the title passed, the value, for tax purposes, seemed to increase, and
• some of these gifts went on for very long periods of time.
In effect, there was the perception that some donors were getting substantial tax benefits without having to provide the public any access to their “gifts.”14 This apparent abuse is what prompted the 2006 and 2007 legislation, which greatly altered the rules governing fractional gifts.15 As of 2007, the rules governing fractional gifts were as follows:
• The tax consequences of the first payment on a fractional gift are governed by the fair market value of the gift at that time. Subsequent payments are governed by the lesser of the following: fair market value of the subsequent gift at time of the payment or the value placed on the initial payment. In other words, subsequent tax benefits can never exceed the original appraisal and could be lower.
• The gift must be paid in full within ten years of the initial payment on the gift or at the death of the donor, whichever is earlier.
• The donor and donee must have an arrangement whereby the donee has possession of the gift property for periods that reflect the donee’s current amount of ownership in the gift property.
• The fractional gift model cannot be used if someone other than the donor and donee has an interest in the property.
In effect these changes abolished most of the benefits that had previously attracted donors to this method of giving, much to the dismay of many museums. As mentioned earlier, there are now ongoing efforts by the profession to temper some of these new rules, and so this is an area of the law that needs to be monitored for possible change.
In any event, fractional gifts should be prepared with expert assistance so that current IRS criteria are met and eventualities are provided for in writing. For example, there should be at least an understanding between the parties as to how “periodic possession” of the property will be handled, how insurance coverage is arranged as well as transportation expenses, what standards of care should be met by each party, whether either party can lend the object to a third party while it has custody, and how copyright or reproduction questions are handled. Another important consideration for the museum is assurance that the donor’s will confirms that any remaining interest in the gift property passes to the donee organization at the donor’s death.
A bargain sale (or donative sale) arrangement may be proposed by the owner of an object that is desired by a museum. Here the owner offers to sell the object to the museum for less than its fair market value because, in this way, the owner receives some remuneration plus a charitable contribution for the portion “given” to the museum.16 Such an arrangement is legitimate if, in fact, it is a true “bargain sale.” Although the burden of proving fair market value to the IRS rests with the donor, this is one instance in which it may be proper for the museum to comment on the value of a donated object—by acknowledging in writing that it perceives it is purchasing the object at less than fair market value. Such an acknowledgment, which should not attempt to state or confirm a fair market value dollar figure, merely rebuts the normal presumption that the sale is an arm’s-length transaction.
In handling a bargain sale, a museum should keep in mind the following points: (1) the museum should have written evidence that the owner has a donative intent in setting the sale price (that is, evidence that the donor is intentionally setting a low price); (2) the museum should make an informed judgment that the purchase price is significantly less than apparent fair market value; (3) the museum should not approve or appear to approve any dollar figure as constituting fair market value; and (4) clearly, the museum should not endorse or appear to endorse an inflated value in order to give the owner undeserved tax advantages. The prudent museum proceeds very cautiously if there appears to be inflated value, and at a certain point, a rather frank discussion with the owner may be in order before negotiations continue.
If the museum enters into the bargain sale, a standard deed of gift would not be used because title has passed by virtue of the contract of sale. It is appropriate, however, to note on the contract of sale and on accession records that the transaction is a bargain sale or donative sale. After payment has been made and the object received, usually a letter is sent to the seller acknowledging the museum’s perception that the transaction was a bargain sale and expressing gratitude for the resulting “gift” to the museum. Also, in light of the gift element of the transaction, two additional factors need to be considered.
First, when the value of the gift portion of the bargain sale exceeds $5,000, IRS requirements concerning “qualified appraisals” (see Chapter XIII, “Appraisals and Authentications,” Section A, “Appraisals”) are triggered if the donor intends to seek a tax deduction. This means the museum will be required to complete a portion of the seller’s IRS Form 8283, “Noncash Charitable Contributions,” whereby the museum acknowledges receipt of the “gift” element of the transaction. (On Form 8283, the donor should have noted the receipt of the “sale price” from the museum.)
Second, when the value of the gift portion of the bargain sale exceeds $250, the museum must provide the seller with the receipt explained in this chapter’s Section F.2 “Substantiation of Gifts,” in order to enable the seller to claim a charitable deduction.
As noted in this chapter’s Section B, “Income Tax Consequences of Charitable Gifts to ‘Publicly Supported’ Museums,” the simple rule is that a gift of cash is valued at its dollar amount for purposes of a charitable contribution deduction. But human ingenuity allows few tax rules to remain simple for long.
As charitable organizations became more competitive and inventive in seeking support, their fund-raising endeavors entered the marketing age. No longer did the organizations issue simple pleas for funds; rather, prospective contributors were encouraged—by ever escalating offers of gifts, parties, or services—to join “friends” groups, to contribute money, or to take part in charity auctions. As a result, many checks were being written to charities—and then reported as charitable contributions—when in fact the checks were buying valuable benefits.
The position of the IRS on the deductibility of payments made to charities conducting fund-raising events has long been as follows: “Only that portion of a charitable contribution which exceeds fair market value of a ‘premium’ or other substantial benefit given to the donor in exchange for a contribution is considered to be a gift and is therefore deductible.”17 Two corollary positions of the IRS are as follow:
• If a charitable contribution deduction is claimed for a payment to a charity and the payment carried with it some premium or other substantial benefit, the burden is on the taxpayer to establish that the amount paid is not the purchase price of the premium or other substantial benefit and that part of the payment, in fact, does qualify as a gift. (But note, as explained hereafter, that as of 1993 the charity now shares some of this burden.)
• The fact that the premium or other substantial benefit was not used by the taxpayer is not relevant. What is relevant is whether the taxpayer was entitled to receive something of substantial value in return.18
To cover themselves in this regard, charities, when issuing tickets or publicity regarding solicitations that carry benefits of some type, began a practice of adding the phrase “deductible to the extent provided by law.” In fact, this statement helped the average taxpayer little because even if the taxpayer was aware of the relevant Internal Revenue Code provisions, he or she usually was poorly prepared to set a dollar value on the benefits offered. In the late 1980s, in response to evidence that more and more taxpayers were reporting as charitable contributions checks that in fact resulted in substantial benefits, the IRS initiated a strong appeal to charities, urging their cooperation.19 In 1988, the commissioner of the IRS took the unusual step of writing directly to over four hundred thousand charities, expressing his concern that charities, as sponsors of fund-raising events, often failed to provide sufficient information to taxpayers regarding the extent to which payments for such events were deductible as charitable contributions. He directed their attention to a 1967 Revenue Ruling20 on this subject and said the following:
I would particularly like to emphasize that part of the ruling which states the importance of determining in advance of solicitation the portion of payment attributable to the purchase of admission or other privilege and the portion solicited as a gift.
The ruling says that in those cases in which a fund-raising activity is designed to solicit payment intended to be in part a gift and in part the purchase price of admission or other participation in an event, separate amounts should be stated in the solicitation and clearly indicated on any ticket or other evidence of payment furnished to the contributor.21
Efforts were then renewed within the museum community to encourage more careful adherence to IRS directives on this subject, and quite naturally many questions arose. A good number of these questions concerned the method that should be used to put a dollar figure on the unique benefits that were frequently offered to contributors but that had no discernible fair market value (e.g., a discount privilege in museum shops; invitations to preview exhibitions with a curator acting as a guide; the use of a museum space, not normally rented, to host a private party).22 Progress in clarifying these issues and educating the public was slow.
In 1993, what had been essentially voluntary cooperation was, by statute, made mandatory. Under the Omnibus Budget Reconciliation Act of that year,23 charities were required, as of January 1, 1994, to provide donors with a good-faith estimate of the value of any goods or services offered in return for a gift. In addition to providing this good-faith estimate, the charity also has to provide a written statement to the donor explaining that the amount of the contribution that is deductible is limited to the excess of the amount contributed over the value of the goods or services connected with the gift.24 These statutory requirements went into effect for gifts solicited or made after December 31, 1993, and they apply when a donor, either an individual or a corporation, makes a gift in which the payment to the charity exceeds $75. Charities failing to comply with the statutory requirements are subject to penalties.25
In December 1996, the IRS issued final regulations that clarified how these new provisions are to be implemented.26 The regulations state that certain offered benefits can be deemed insubstantial and need not be included when calculating quid pro quo. Insubstantial benefits, which can be exercised frequently, include a membership privilege of free or discounted admission or parking, a discount in the organization’s shop, or admission to an event open only to members if the cost per person of what is provided is nominal. Newsletters and other publications sent to members (as long as the publications are not sold to others) are deemed insubstantial benefits also. If the total value of benefits associated with a gift is nominal, the donee organization can inform the donor that there is no quid pro quo associated with the gift, and if a written acknowledgment is required because the gift exceeded $75, the donee organization can state on that acknowledgment that no goods or services27 were provided in exchange for the gift. What constitutes “nominal” benefits is defined in dollars and cents by the IRS, subject to annual adjustment. As of late 2010, the definition was “$9.60 or less.”
The Omnibus Budget Reconciliation Act of 1993 imposed another requirement that donors who claim an income tax deduction for a contribution of $250 or more must obtain a receipt from the donee organization before filing their income tax returns.28 The receipt must include the amount of cash donated or a description of the property donated (no dollar value need be placed on the property by the donee organization), and if any goods or services accrue to the donor in exchange for the gift, an estimate of the fair market value of such goods or services must also appear on the receipt. If no goods or services were provided in exchange for the gift, the receipt must specifically make that statement. The before-mentioned IRS regulations applicable to gifts with premiums and benefits—regulations concerning what is reportable as a premium or benefit, methods for determining fair market value of goods and services, and what constitutes “nominal” value regarding quid pro quo benefits—can be used by donee organizations when preparing receipts requested by those who have donated $250 or more.29 Because donors can be denied a charitable contribution deduction when the receipts, as described in this section, have not been obtained within appropriate time periods, museums should have their procedures in order so that no donor suffers as a result of the donee organization’s inefficiency.
For purposes of clarity, we should note that as of 1985 other Internal Revenue Code requirements that fall under the general heading of “substantiation of gifts” have also been in effect. The 1985 requirements are distinct from the 1993 substantiation rules (and are not affected by those rules). They are essentially as follows (see Chapter XIII, “Appraisals and Authentications,” for a fuller description). As of 1985, a donor who makes a gift or group of gifts that exceeds $5,000 in value must, for purposes of documenting a charitable contribution deduction, obtain a “qualified appraisal.” When a donee organization is the recipient of such a gift, it must sign a form presented by the donor (Section B of IRS Form 8283), verifying receipt of the property, and it must give the donor and the IRS written notice (IRS Form 8282) if it disposes of the property within three years of receipt. See Chapter XIII, “Appraisals and Authentications,” Section A, “Appraisals,” and Chapter V, “The Disposal of Objects: Deaccessioning,” Section B.2.e, “Notification to Donor of Deaccession,” for more detailed information on these particular substantiation requirements.
Considerable discussion is generated whenever the topic is the museum’s proper role regarding the tax consequences of donors’ gifts. Some favor a complete “hands off, it’s not our problem” approach, whereas others argue that museums should take an active role in probing apparent abuses. If there is a “right” answer for a museum, it probably lies somewhere in between. Good intentions must be reconciled with what is possible, and even with a prudent general policy, staff must stay informed and be vigilant for the unusual circumstances that require special treatment. Consider the following examples.
Hypothetical Example 1. A respected friend of the museum offers to donate a painting represented as a work of artist X and appraised at $15,000. The donor presents the appropriate paperwork, a copy of a current appraisal and the required section of Form 8283. The museum accepts the gift and signs Form 8283 acknowledging receipt of the painting. However, the painting is never put on display. Some years later, several researchers establish that the painting is not authentic. On investigation, the researchers discovered that the curatorial staff of the museum had serious doubts about the authenticity of the work when the gift was made but that no one wanted to offend a donor who might offer something more interesting next time. Instead, the required steps were taken to complete the transfer after museum staff convinced themselves there was nothing to be gained by stepping into a matter that essentially involved the donor and the IRS.30 The painting was stored out of public view for over three years, the statutory period during which the IRS could have questioned the deduction taken (that is, the claimed value of the charitable donation).
Hypothetical Example 2. A museum has on loan an unusual ethnographic object that it would like to have for its collections. The owner explains that he cannot afford to give the work but asks the museum to help him search for a prospective donor who will buy the object and then, after an appropriate period, give the piece to the museum. A prospective donor is located, and the museum becomes privy to the fact that the donor paid a reasonable sum for the object, and he is now bragging that he can established that the object is worth much more when it comes time to make the donation. After a year passes, the donor arrives at the museum with a qualified appraisal for an amount double what was paid for the object, and the required IRS Form 8283 is signed without comment.
Hypothetical Example 3. Curator X finds himself flooded with offers of donations of a particular type of property that he knows is being promoted as a tax shelter. The museum’s collections are already well represented in this area, but nothing is refused. The donors have obviously acquired the property items merely to be donated later for tax benefits far in excess of their investments. Valuations substantially over the purchase price are being sought. Curator X plans, after the donations are held for a discrete period, to sell or exchange most of this material, but the realities are never openly discussed by the donors or the museum.
In each of the above examples, it is quite possible that a museum might come forward with a legitimate explanation for its conduct, based on particular circumstances, but such explanations tend to wear thin when a pattern develops. To the careful observer, museum personnel who “look the other way” appear (at a minimum) unethical; a consistent pattern of such behavior in recurring situations might amount to participation as a silent coconspirator in a tax-evasion scheme. In any event, even the mere appearance of participation in systematic abuse can tarnish a museum’s reputation in the eyes of the general public.
And even those who are not particularly motivated by ethical exhortations regarding the importance of personal integrity should review the practical consequences of pushing the edge of the law in the area of charitable contribution deductions. Over the past decade or two, publicly supported charitable organizations have become burdened with numerous regulatory requirements spawned by public perceptions that these organizations have been cooperating in or condoning abuses of the charitable contribution deduction. At one point, the charitable deduction itself was at stake.31 Even the most pragmatic individual who takes the time to review this history should come to this conclusion: A museum that does not take seriously adherence to IRS regulations concerning charitable contributions is incredibly shortsighted. It puts at risk not only its own reputation, but also that of the museum community.32
How a museum classifies and treats its collection objects can have a variety of important ramifications for the museum, and it is becoming increasingly important for a museum to identify and address such situations before it finds itself faced with unanticipated and unfortunate consequences. One of these situations concerns how collection objects are to be classified in various financial documents that a museum may be called upon to produce, such as balance sheets, audit reports, tax returns, etc.
First, a bit of background information is in order. Depending on the mission of a museum, the term “collection objects” would mean the property owned by the museum and subject to its collection management policy. Thus the term could include within its scope a wide variety of things as well as historic structures. Stated another way, the term “collection objects” means the property that has been acquired by the museum and is managed solely for the purpose of furthering the educational mission of the organization. As museums became more professionally run, it became apparent that it was important to establish standards regarding how “collection objects” were used and cared for because without these objects there would be no museum. Earlier chapters of this book discuss the care and handling standards for collection objects. In this chapter, we include a more recent set of standards that recognizes that collection objects are in some respects quite different from a typical “asset.” As usually defined, an “asset” is owned property that can be sold for any purpose, mortgaged, or used as collateral for a loan. But should museum objects be used for such purposes when each such action places the object at greater risk? Before long the museum profession articulated ethical standards that in effect stated that museums should not “capitalize” their collections, that is, not engage in selling, mortgaging, or using their collection objects as collateral. The reason given for this caution is that such actions place unacceptable risks on the very things museums are supposed to protect. The ethical standards do provide some leeway if proceeds from the sale of collection objects are earmarked for purchase of new collection objects or direct care of the collection. (See Chapter V, “The Disposal of Objects: Deaccessioning,” Section B.2.f, “Use of Proceeds Derived from Deaccessions,” for a fuller explanation of this exception.)
Although these ethical standards were generally accepted by the museum community, problems arose with the accounting profession. To an accountant an asset is an asset, thus how can a valid financial statement be created, or an audit be conducted, or a tax return be prepared for museums, when museums insist that they have two kinds of assets? After much discussion with the museum profession, the Financial Standards Board of the Financial Accounting Foundation (FASB) published accounting standards for the capitalization of collections by private, nonprofit institutions. These are known as the FASB Statement of Financial Accounting Standards No. 116: Accounting for Contributions Received and Contributions Made (FAS 116). The FAS 116 was then accepted by the Government Accounting Standards Board (GASB).
Under both FASB and GASB standards, a museum has the option to elect to follow traditional accounting standards or to adopt the standards created especially for museums. However, both FASB and GASB standards set forth what constitutes a “collection object,” in other words, what property in a museum is eligible to use these special standards. The FASB/GASB standards state that only objects that meet all of the following conditions are eligible: objects that are
a. held for public exhibition, education, or research in the furtherance of public service rather than financial gain;
b. protected, kept unencumbered, cared for, and preserved; and
c. subject to an organizational policy that requires that the proceeds from sales of collection items be used to acquire other items for the collections.
So far there have been mixed reactions to the FASB/GASB standards, but it is too early to make any solid judgments. For example, within the museum profession the various professional organizations and disciplines have been unable for some time to reach common ground on the interpretation of the exemption regarding use of proceeds derived from a deaccession. Differing views on this issue raise problems for accountants and museum boards, because there is as yet no official guidance. For example, if a museum board elects to follow the special rules, it means the organization’s balance sheet will not show the value of the collections, whereas a comparable museum choosing to capitalize its collections will appear to many to be better run because it appears to have acquired far more property than the other. Also, when seeking various types of insurance, competing for grants, or soliciting donations, the museum with the more impressive balance sheet may have an edge over the museum that does not capitalize its collections. For some boards, these possible side effects make it very difficult to decide which way to go on the capitalization issue.
There is also another development that needs to be considered when a museum is deciding whether it should capitalize its collections. As mentioned earlier, the IRS when preparing the new Form 99033 added many questions concerning how nonprofits are actually operating. Schedule M of the new Form 990 Form deals with “noncash contributions,” and it must be completed by any nonprofit receiving noncash contributions worth more than $25,000 in a tax year. Museums need to give special attention to this schedule because in order to file it correctly certain distinctions need to be made.
Schedule M sets out twenty-two categories of objects, and reporting is done by category. In other words, how many art pieces, how many collectibles, etc., were donated. If a museum does not capitalize its collections, it needs only to identify the number of donated objects in each category that it has received. However, if the museum does capitalize its collections, it must not only give the number of objects in each category that it has received but also place a value on the objects in each category.34 (This is just one more issue that further complicates for a museum the decision of whether or not to capitalize its collection.) Another matter a museum needs to bear in mind with regard to schedule M is not to forget to report noncash donations that were not put to a “related use” by the museum. The fact that a donated object was not put to a “related use” does not exempt it from coverage under Schedule M. A noncash contribution that is not used for “exempt purposes” is treated as a regular asset and reported with a stated value. Lastly, one of the categories in Schedule M is reserved for information on noncash donations of art that take the form of fractional gifts. (See this chapter’s Section D, “Spreading Out Charitable Deductions,” to refresh your memory about fractional gifts.)
It bears repeating that the tax matters discussed in the last half of this chapter are in a state of flux, and periodically it is important to check for any new developments in this area.
1. See also Chapter IV, “The Acquisition of Objects: Accessioning,” Section F, “Acquisition Procedures,” regarding such issues as record keeping for tax purposes and when a gift is complete for tax purposes. See Chapter II, “Museums Are Accountable to Whom?,” Section E, “Oversight by Taxing Authorities,” and Chapter XIII, “Appraisals and Authentications,” Section A, “Appraisals.”
2. For more comprehensive discussions of tax considerations, see Comment, “Tax Incentives for Support of the Arts: In Defense of the Charitable Deduction,” 85 Dick. L. Rev. 663 (1981); IRS Publication 526, Charitable Contributions; and IRS Publication 561, Determining the Value of Donated Property.
3. IRS Publication 557, Tax-Exempt Status for Your Organization, should be consulted for instructions regarding application for exempt status.
4. Under IRS regulations, an organization will be regarded as “operated exclusively” for an exempt purpose if it engages “primarily” in activities that accomplish such purpose. Treasury Regulations 26 C.F.R. § 1–501(c) (3)-1(c)(1).
5. If a 501(c)(3) organization such as a museum cannot demonstrate “publicly supported” status (by one of several tests), it is treated as a private foundation. A private foundation is subject to special record keeping and reporting requirements, is restricted in its dealings with certain organizations and individuals, and offers less-favorable tax benefits to its donors.
6. In 2011, the holding period to turn short-term capital gain into long-term capital gain is one year. This period is adjusted occasionally by legislation, so current law should be checked.
7. See IRS Publication 561, Determining the Value of Donated Property. For a general discussion of perceived or real abuses of the charitable contribution deduction, see J. Lyon, “Charitable Contributions of Appreciated Property: A Perspective,” in American Law Institute–American Bar Association (ALI-ABA), Course of Studies Materials: Legal Problems of Museum Administration (Philadelphia: ALI-ABA, 1987). For information regarding the valuation of unique objects, see N. Ward, “What Is Fair Market Value and How Is It Established?,” in American Law Institute–American Bar Association (ALI-ABA), Course of Studies Materials: Legal Problems of Museum Administration (Philadelphia: ALI-ABA, 1986); P. Geolat, “Valuation of Natural History and Other ‘Non-Art’ Objects for Charitable Deduction Purposes,” in American Law Institute–American Bar Association (ALI-ABA), Course of Studies Materials: Legal Problems of Museum Administration (Philadelphia: ALI-ABA, 1990); and N. Ward, “Valuation of Natural History and Other ‘Non-Art’ Objects for Charitable Deduction Purposes,” in American Law Institute–American Bar Association (ALI-ABA), Course of Studies Materials: Legal Problems of Museum Administration (Philadelphia: ALI-ABA, 1990).
8. IRS Publication 561, Determining the Value of Donated Property. On the somewhat related issue of whether there are conditions that affect the “delivery” of the gift, see Chapter IV, “The Acquisition of Objects: Accessioning,” Section F.4, “Special Tax Considerations.”
9. The “related use” restriction applies to gifts for which an income tax charitable contribution deduction is taken. There is no similar restriction on estate tax charitable contribution deductions except for § 2055(e)(4) of the Internal Revenue Code, which applies to bequests of property with copyright ramifications.
10. See Note, “Tax Treatment of Artists’ Charitable Contributions,” 89 Yale L. J. 144 (1979). Numerous bills have been introduced into Congress to give relief to artists and others who want to donate their own work to charity, but as of the close of 2010, none have been enacted.
11. Regulations 26 C.F.R. § 1.170.A-4(b)(3). See also 26 U.S.C. § 170(e)(1)(B).
12. See IRS Publication 526, Charitable Contributions.
13. See also the comments in Chapter V, “The Disposal of Objects: Deaccessioning,” Section B.2.e, “Notification to Donor of Deaccession,” which explains IRS notification requirements if certain gifts are transferred by a museum within three years of receipt.
14. See S. Strom, “The Man Museums Love to Hate,” New York Times, Dec. 10, 2006, accessed Mar. 16, 2011, http://www.nytimes.com/2006/12/10/arts/design/10stro.html.
15. See Section 1218 of the Pension Protection Act of 2006 as amended by the Tax Technical Corrections Act of 2007.
16. For information on determining the tax consequences of a bargain sale, see IRS Publication 526 and “Other Dispositions” in IRS Publication 544.
17. How Much Really Is Tax Deductible? (Washington, D.C.: Independent Sector, 1988), 3.
18. The Revenue Ruling cited most often on this issue is Rev. Rul. 67-246, 1967-2, C.B. 104, accessed May 18, 2011, http://www.irs.gov/pub/irs-tege/rr_67_246.pdf. See also Rev. Rul. 86-63, 1986-1, C.B. 88, 19.
19. See IRS Publication 526, Charitable Contributions (2010), accessed May 18, 2011, http://www.irs.gov/pub/irs-pdf/p526.pdf, and IRS Publication 1771, Charitable Contributions—Substantiation and Disclosure Requirements (2010), accessed May 18, 2011, http://www.irs.gov/pub/irs-pdf/p1771.pdf.
20. See this chapter’s footnote 18.
21. See this chapter’s footnote 19.
22. N. Ward, “What Is a Reasonable Estimate of the Fair Market Value of a Wrong Note?,” Exempt Organization Tax Review (April–May 1989); J. Blazek et al., “Fund Raising Events after Publication 1391,” in American Law Institute–American Bar Association (ALI-ABA), Course of Studies Materials: Legal Problems of Museum Administration (Philadelphia: ALI-ABA, 1990).
23. H.R. 2264 (1993).
24. The statement must be in a form and size that make it easily visible to the donor. See also IRS Publication 1771.
25. See American Association of Museums, Government Affairs Bulletin, Aug. 30, 1993.
26. Proposed regulations were issued in the Federal Register on Aug. 4, 1995, pp. 39896–902. The regulations were effective upon publication and remained in effect until the final regulations were promulgated on Dec. 16, 1996. See 61 Fed. Reg. 65946–55 (Dec. 16, 1996), accessed May 29, 2011, http://www.gpo.gov/fdsys/pkg/FR-1996-12-16/pdf/96-31719.pdf.
27. There are exceptions to what constitutes “goods or services.” See IRS Publication 1771 for details.
28. Failure to obtain a receipt in a timely manner invalidates the claimed deduction. When the statute first went into effect, a time extension was granted for obtaining receipts.
29. See the final regulations cited in this chapter’s footnote 26.
30. Because the gift was represented to be worth over $5,000, the donee museum was asked by the donor to sign Section B of IRS Form 8283, “Noncash Charitable Contributions,” in which the donee organization verifies that it has received from the donor the described gift.
31. See, for example, J. Lyon, “Charitable Contributions of Appreciated Property: A Perspective,” in American Law Institute—American Bar Association (ALI-ABA), Course of Studies Materials: Legal Problems of Museum Administration (Philadelphia: ALI-ABA, 1987); and J. Simon, “The Tax Treatment of Nonprofit Organizations: A Review of Federal and State Policies,” in W. Powell, ed., The Nonprofit Sector: A Research Handbook (New Haven, Conn.: Yale U. Press, 1987).
32. As of 2008, the IRS has substantially revised its Form 990 (the annual return for exempt organizations) so that the form now asks questions about a museum’s collecting policies, the number and type of objects that are being collected, and other questions that give a clearer picture of whether museums are adhering to IRS regulations. The pre-2008 Form 990 was composed of nine pages plus two schedules; the new Form 990 is composed of eleven pages plus sixteen schedules. If information gleaned from the use of these new forms supports the view that many charitable organizations are not following IRS regulations, charities may find themselves faced with serious efforts on the part of legislators to cut many of the benefits they have long enjoyed.
33. See American Association of Museums’ Sept. 12, 2007, electronic letter to IRS, commenting on “Redesigned Form 990,” accessed Mar. 18, 2011, http://www.aam-us.org/getinvolved/advocate/issues/upload/2007_AAM_Comments_on_Form_990_to_IRS.pdf.
34. Schedule D of Form 990 also requires any organization that does not capitalize its assets to provide the text of the footnote from its financial statement that describes these items.