Fair Warning: Artwork, Private Foundations, and Self-Dealing

The weekend has ended and Art Basel – Miami 2016 has concluded. To many U.S. taxpayers, it’s just another Monday, but to serious collectors who attended this vibrant art fair focused on contemporary paintings and sculptures, this was a major event. Now faced with anticipated shipments and bills, those who made substantial additions to their collections may be thinking “Hmmm, what am I going to do with all of this?”

For the short-term, they may be fine. However, a long-term solution to this question may be for the collector to create a private foundation to hold their art. A foundation may be a wonderful charitable vehicle for a donation of artwork and may be established as a stand-alone entity or in conjunction with creating a private museum. In return for the donations, the donor receives tax benefits, the foundation basically operates tax-free, and the public has the opportunity to experience artwork previously unavailable to them. Before making any commitment, though, a collector should be aware of two important terms: “disqualified person” and “self-dealing”.

1. Disqualified Person[i]

Being a “disqualified person” doesn’t mean you’ve done anything bad, it just means there are restrictions on the interactions you can have with a private foundation. While there are seven categories of “disqualified persons,” the most relevant is the one involving the founder who contributes the artwork. Typically, this person is referred to as a “Substantial Contributor.”[ii] Another common type of disqualified person is a manager of the foundation, like a trustee, officer or director. Certain family members of substantial contributors and foundation managers may also be disqualified persons.[iii]

2. Self-Dealing[iv]

The purpose of self-dealing is to prevent the founder and other disqualified persons from, directly or indirectly, benefitting from the operation of the foundation. It is a primary reason why the founding donor must have real philanthropic intent: once artwork is contributed to the foundation, there is no going back, and the donated objects belong irretrievably to the private foundation. As an entity entirely separate from the founding donor, the activities of the foundation may only be for the furtherance of its charitable mission. Ensuring that the interactions of founding donors and other disqualified persons steer clear of self-dealing is sometimes the tricky part – especially when it comes to art.

Acts of Self-Dealing: Self-dealing isn’t always as obvious as you might think. Sometimes it occurs even though good intentions were involved. The following list provides an overview of activities considered to be self-dealing between a private foundation and a disqualified:[v]

  1. The sale, exchange or leasing of property,
  2. Lending money or other extension of credit,
  3. Furnishing goods, services or facilities,
  4. Paying compensation or paying or reimbursing expenses to a disqualified person,
  5. Transferring foundation income or assets to, or for the use by or the benefit of, a disqualified person, and
  6. Certain agreements to make payments of money or property to government officials.

A Closer Look at Artwork Donated to a Foundation and Self-Dealing

On the surface, the above rules may look straightforward, but they are prone to interpretation and ambiguity. If self-dealing is determined to exist, potential tax consequences and penalties may be assessed by the IRS. In the case where the artwork in question is valued into the hundreds-of-thousands or even millions of dollars, the exposure to penalties and excise tax can be substantial. (See the end of the article for more information).

The following scenarios provide some insight into how the question of self-dealing may arise when artwork is held within a private foundation:

Warning: Don’t Do This At Home[vi]

This is from a revenue ruling going back to 1974, but it has withstood the test of time and is often used for comparison. A private foundation placed three of its paintings in the residence of a substantial contributor (therefore a disqualified person), who had a “large” private art collection in what sounds like a separate wing of their home. Twice a year, this person organized tours of the private art collection, including the foundation’s three paintings, for about 2,000 visitors. Additionally, special small group tours were organized for people associated with the arts.

We don’t know anything about the three paintings from the revenue ruling: we don’t know who the artists were, how much the paintings were worth, or the cultural significance of the paintings. None of that matters. It also doesn’t matter whether more people saw the foundation’s three paintings while on view in the private collection as opposed to where they were previously on exhibit (if they even were).

What does matter is that a disqualified person had direct use of the paintings as exhibited by the sole control exercised over determining when the public could view the paintings. The Service found self-dealing existed under Section 4941(d)(1)(E) because the disqualified person was using the foundation’s assets despite the foundation’s paintings being sometimes made available to the public.


This is an example of best intentions gone awry. A foundation planned to sell a number of its paintings and artwork at a public auction to the highest bidder. The promotion by the gallery was broad and implemented to “attract the widest possible attention among potential buyers of art objects.”[viii] Meanwhile, a disqualified person to the foundation selling the artwork intended to purchase a number of the foundation’s paintings by outbidding the other participants. There were no backroom deals – all of the bidding was to be done publicly to obtain the best price possible.

In this case, the Service found self-dealing under Section 4941(d)(1)(A) from a direct or indirect sale of property between a private foundation and a disqualified person. Intention was not a consideration. While the sale was being conducted in public by an auction house and anyone with the financial wherewithal and interest could bid, the auctioneer was acting as agent for the private foundation (the seller). This resulted in the seller and the highest bidder/disqualified person being principals to a sale, despite the involvement of the auction house.

“Everybody’s gotta have a little place for their stuff. That’s all life is about. Trying to find a place for your stuff.” George Carlin[ix]

A disqualified person to both a foundation and a museum, which operated as a foundation, wanted to loan works of art from his collection to both, free of charge. The question then arose as to where this personally owned artwork could be stored while on loan to either the foundation or the museum.[x] The disqualified person wanted to store it at the museum (which seems like a pretty good place to store your stuff if your stuff is artwork). However, a second question then arose: was this self-dealing because the museum, a private foundation, was furnishing facilities to a disqualified person and the disqualified person would not be charged for this storage.[xi]

The Service in its analysis determined that the benefit of the storage was merely incidental to allowing the museum and foundation achieve their charitable purposes. In particular, the Service pointed to the percentage of time the loaned artwork was expected to be in use for charitable purposes at any given time as well as during a five to seven year period. As a result, it ruled that the storage of the personally owned artwork at the museum was not an act of self-dealing. Maybe even the IRS knows how hard it is sometimes to find a place to put your stuff.

Is That a Yue Minjun[xii] Hanging in Your Lobby or Are You Just Happy to See Me?[xiii]

A museum was set up as an operating foundation to develop an interest of the general public in art by hosting outdoor and indoor museums, art exhibitions, and music and dance performances for cultural and educational purposes. It would do this by hosting these artistic events throughout a “park like office complex…consisting of 200 acres” made up of public greenbelts, common areas and almost 50 commercial buildings. The disqualified persons were involved in developing or building more than a dozen of the commercial buildings on this complex. The disqualified persons had also donated much, but not all, of the artwork owned by the museum.

The question here was whether there was self-dealing through the use or benefit of the assets of the museum if the museum’s artwork was placed in the lobbies of the commercial buildings associated with the disqualified persons.[xiv] The Service did not find self-dealing in this situation. The artwork in the lobbies was accessible to the public and none of it was placed in private offices.

Additionally, only a small number of artworks were displayed in the buildings owned by the disqualified persons. Plus, the Service determined that the disqualified persons retained no control over the public access[xv] to the artworks nor did they retain direct use of the artworks. Importantly, the Service found that by placing the artwork in these private properties, the museum was furthering its exempt purpose of an outdoor museum without having to purchase additional properties.

New Meaning to “Browsing” at the Neighborhood Mall[xvi]

A private foundation had been created to promote public awareness and appreciation of leading twentieth century artists and their artwork through a contribution by the founder of his significant collection of modern art. A museum was also created by the founder and the foundation loans artwork to this “Art Center.” Due to the size of the art collection, over 350 pieces in all, only about one-third could be exhibited at any point in time.

To reach more members of the public, the foundation wanted to lend a small number of the items in the foundation’s art collection, just five to ten pieces, to a local shopping mall. The intention was to encourage people to visit the Art Center. While the founder had since passed away, his daughter and her husband were considered to be disqualified persons: first, she was a family relation to the founder; second, they were both foundation managers; and third, together, they owned more than 35 percent of the shopping center.

Here the question was whether self-dealing existed because goods were being furnished between a private foundation and disqualified persons. In this case, the IRS looked at who would be benefitting from this display of twentieth century artists and determined the viewing public to be the primary beneficiary. They also determined that such a display of the artwork was in furtherance of the foundation’s mission and no self-dealing was found.

Analyzing Self-Dealing with Artwork

There is no clear answer to whether a situation involving artwork may actually be self-dealing without a determination by the IRS. However, there are some questions to consider to make an initial assessment:

  • Do any of the parties to the transaction meet the definition of disqualified person?
  • What is the basis of the transaction?
  • Is there a sale of artwork?
  • Is the artwork being loaned out?
  • Is the artwork being loaned free of charge to the foundation?
  • Do disqualified persons have an interest in the properties or locations to which the foundation is loaning artwork?
  • Who is getting to use the artwork?
  • Is there a furnishing of facilities involved?
  • Who is the primary beneficiary of the artwork?
  • Who is the seller and who is the purchaser?
  • Does the transaction further the charitable purpose of the foundation?
  • What level of access is the general public being afforded?
  • Is the benefit to the disqualified person merely incidental or tenuous?
  • If the transaction appears to be one of self-dealing, does an exception apply?

Each situation will be unique, so, proceed with caution, regardless of how well-intentioned and charitably inclined a transaction may be. With self-dealing penalties ranging from 5 – 10% of the amount involved[xvii] and the public accessibility to Form 990, an act of self-dealing can be potentially devastating both to the finances and reputations of all involved. Having good and knowledgeable advisors is an important defense. Also, consider requesting an IRS ruling prior to proceeding. Depending on the situation, it may be well worth the cost.

In the meantime, savor your artwork. Enjoy the beauty of expression that it brings to your life. Then, later, consider a future in which that beauty may be shared.

[i] IRC Section 4946(a).

[ii] IRC Section 4946(a)(2).

[iii] Other categories exist and the full listing of definitions can be found under IRC Section 4946.

[iv] IRC Section 4941.

[v] See IRC Section 4941(d).

[vi] See Rev. Rul. 74-600.

[vii] See Rev. Rul. 76-18.

[viii] Id.

[ix] George Carlin was an American comedian. More information about him can be found at http://www.imdb.com/name/nm0137506/.

[x] See PLR 201423032.

[xi] Treas. Reg. Section 53.4941(d)-2(d)(3).

[xii] Mr. Minjun often paints self-portraits in which he appears to be smiling or grinning (it’s more complicated than that). For more information about Mr. Minjun, the following article may be of interest: http://www.nytimes.com/2007/11/13/arts/design/13smil.htm.

[xiii] See TAM 9221002.

[xiv] See IRC Section 4941(d)(1)(E).

[xv] Compare to the earlier decision in Rev. Rul. 74-600.

[xvi] See PLR 201029039.

[xvii] These penalties may increase up to 200% if the transaction is not corrected within the taxable period.

The material in this publication does not constitute legal advice. It is intended for general information purposes only. If you have questions or need assistance with charitable planning and charitable donations, the attorneys at M. Robinson & Company may be able to assist you. Please feel free to contact us at 617-428-6900.

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