July 2, 1998
Non-Profit Update # 15 (Museums)
Below are several new tax items of specific interest to museums from the past year or so.
I. IRS Willing to Review Art Appraisals Before Tax Returns Are Filed
Revenue Procedure 96-15, 1996-3 I.R.B. 41, establishes procedures to request a Statement of Value from the Service. This helps taxpayers who are required to value art for income, gift and estate tax purposes.
IRS regulations provide that art donated, transferred by gift, or transferred upon death is valued at Afair market value.@ This is the amount a willing buyer would pay a willing seller, where both have reasonable knowledge of the facts, and neither is forced to buy or sell. The best evidence of fair market value is an appraisal from a qualified appraiser, based upon comparable sales data. However, fluctuations in art markets, lack of recent comparable sales data, and other variables may have an effect on an appraiser=s determination of fair market value. Thus, appraisers may place different fair market values on the same work of art.
Rev. Proc. 96-15 provides taxpayers an opportunity to request a Statement of Value of Art from the Service. Taxpayers may then rely upon this Statement of Value when completing their returns. Previously, the Service refused to review, approve, disapprove, or issue advance rulings on appraisal for income tax charitable deductions. (Rev. Proc. 66-49, 1966-2 C.B. 1257.)
If a work of art has been appraised for at least $50,000, Rev. Proc. 96-15 is available if the work of art has been donated, transferred by lifetime gift, or transferred because of a taxpayer=s death.
II. IRS Warns Museums About Travel Tours
Travel tours conducted by museums, colleges, and universities are a high priority for the IRS, and as detailed below, it has recently issued a number of documents in this regard.
The IRS has very recently issued proposed regulations, 63 FR 20156, on travel tours sponsored by exempt organizations. AAll relevant facts and circumstances@ will be used to determine if the tour furthers the organization=s exempt purpose. Factors the IRS will use include whether or not the following exist: a significant amount of time for instruction; Aincidental@ sightseeing time; library-type resource materials; academic credit; and examinations. A copy of the proposed regulation may be downloaded from the IRS= website: www.irs.ustreas.gov.
Museums and other non-profits that offer travel tours need to meticulously document both the planning and execution of such trips in order to prove that they are consistent with the organizations= exempt purposes. This was advised by IRS Exempt Organization Divisions Director Marcus S. Owens on March 20.
At a recent ALI/ABA seminar on the ALegal Problems of Museum Administration,@ Owens warned that income from museum and university tours that purport to be educational but actually are more like vacations could be considered taxable.
Owens listed several factors that revenue agents use to determine whether a tour corresponds with a sponsoring organization=s exempt purpose. These include: (1) the percentage of time spent on education as opposed to recreation; (2) whether academic credit was provided to participants; (3) whether reading lists were included; and (4) whether instruction was provided.
Non-profit organizations should document all parts of the tour, from the planning stages to completion of the tour. A system of records, such as a tour analysis sheet, should be created to demonstrate how the tour was chosen and to link the tour to the organization=s exempt purpose.
Owens explained that for part of a fee to be tax-deductible as a charitable contribution, the tourist must voluntarily make a contribution. A required contribution is not deductible. Additionally, a check for the contribution must be made out to the exempt organization sponsoring the trip and not the non-profit company that conducts it. Promotional materials used to solicit contributions must make clear that a contribution is not required. Also, the non-profit organization should document that contributions are not required.
The IRS also recently issued a Technical Advice Memorandum (TAM) involving a travel program. TAM 9702004 involved travel tours offered by a Section 501 (c)(3) organization. The organization=s activities included conducting study missions, a commission on international affairs, the dissemination of study materials, cooperation with an international federal of communities, and an international travel program.
The international travel program was considered an essential element of the organization=s effort to achieve its exempt purposes. Neither contacts among organization leaders nor classroom study of relevant material by group members was sufficient to achieve the organization=s goals. Direct personal contact between group members and communities throughout the world was deemed essential, as were visits to sites of religious, cultural, and historic interest.
The organization regularly conducted tours to sites chosen by its executive committee and governing council. It actively promoted the tour program through advertising efforts directed at members as well as the publication of an annual travel catalogue. Most trips lasted about two weeks, with a range from five days to four weeks.
The central issue in TAM 9702004 was whether the tour program was substantially related to the organization=s exempt function. Three factors help determine whether this substantial relation exists: (1) how the tour is structured, (2) what the tour consists of, and (3) what the tour accomplishes. The organization=s primary purpose in offering the service must also be determined. This primary purpose test examines the nature, scope, and motivation for a tour, as well as the facts and circumstances of the tour.
The primary purpose test will differ according to the nature of the organization. For educational organizations such as colleges, universities, or museums, programs should include Abona fide educational methodologies@ such as organized study, reports, lectures, and readings. Other relevant factors include whether credit can be earned and whether a tour has a clearly demonstrable connection to an ongoing class or exhibit.
For religious organizations, there are a number of critical factors. These include explicit or implicit religiously derived requirements to visit or worship in particular locations, visits to sites of spiritual importance, planning or leadership by clergy or appropriately trained lay persons, and a structured environment conducive to the enhancement of the religious beliefs of the participants.
For both religious and educational travel, the time spent on the related activities is an important factor. For example, a two hour educational activity may not be sufficient to establish education as the primary purpose of a seven-day tour. Though time allocation is not always conclusive, organizations should be prepared to demonstrate why it should not be if they need to make that case. A class or other educational activity will be given less weight if it is merely Avoluntary,@ especially if alternative recreational activities are available, Also important is evidence reflecting the process of tour selection, design, and advertising, as well as what actually took place on the tour.
Other relevant circumstances demonstrating that a particular purpose is being served may be a final critical factor. Choice of destination is important here.
Applying these principles, the IRS ruled that only certain types of tours relate to an organization=s exempt purpose. Tours that typically consist of an intensive learning experience and involve visits to places of special historic, religious, and cultural significance to the members of the organization were related to the organization=s exempt purpose. Tours that were substantially similar to commercially sponsored tours were not related. The IRS was concerned about a lack of contemporaneous documentation about what actually happened on the latter tours. All that was provided was the material in the travel catalogue.
III. Art Advisory Panel Report
Let me know if you would like a copy of the Art Advisory Panel of the IRS Annual Summary Report for 1996 (15 pages).
IV. Museum=s Restaurant and Gift Shop Sales Produce UBIT
The IRS has ruled in technical advice that the proceeds from an art museum=s restaurant and its sale of children=s merchandise are unrelated business income under section 513. A museum in such a situation was granted relief from back taxes under section 7805.
Proceeds from restaurant sales to museum visitors and employees are generally related to its exempt purpose, while sales to restaurant patrons who do not pay the museum admission fee are not. The Service applied the Afragmentation rule@ under reg. Section 1.513-1(d)(3) to determine that this is true when (1) the museum contracts with a commercial enterprise, (2) the general public has access to the restaurant without having to pay for or visit the museum, and (3) the museum advertises the restaurant monthly in a local magazine.
The museum is classified as other than a private foundation under section 509(a)(1) when it operates a shop where it sells art paraphernalia, including art books, reproductions, greeting cards, puzzles, paint sets, art supplies, and kaleidoscopes for children. In an earlier ruling (LTR 8326003), the IRS said that sale of children=s interpretive teaching items with artistic themes furthered the museum=s educational purpose.
To resolve these rulings, the IRS states that items that develop a child=s artistic ability are substantially related to the museum=s educational purpose. Other items that generally develop a child=s motor skills are not. These latter items include tot blocks, baby play gyms, cooking utensils, fruit and vegetable playsets, and animal shaped wagons.
V. IRS Issues Rulings on Self-Dealing
The Tax Court recently ruled that general maintenance, janitorial, and custodial services are not personal service. Thus the provision of them by a disqualified person to a private foundation is self-dealing. The case specifically involved a museum organized as a private foundation. The court drew a distinction between a charge for services (self-dealing) and compensation for personal services (exempted from self-dealing). Under this ruling, the only services protected by the exception are professional and managerial services, which suggests the court will narrowly construe the rules on self-dealing.
The IRS has recently ruled that activities of a foundation that operates a museum and library are not acts of self-dealing and will not jeopardize tax-exempt status.