In a recent communication, the Internal Revenue Service (IRS) announced its intention to scrutinize potentially improper art donation tax deductions, particularly focusing on promoters encouraging taxpayers to buy various types of art, often at a ‘discounted’ price, with built-in fees for additional services.
An IRS examination can either affirm the claimed fair market value of the donation or conclude that the deduction was improperly given. For tax advisors preparing for such a scenario, there are several crucial steps to consider if the agency contacts their client over a significant tax deduction for artwork donated to a charity.
- Determine if you are the right advisor for the client to cope with the IRS examination, considering factors such as tax knowledge, understanding of related-use rules, adjusted gross income limitations, appraisal expertise, and potential conflicts of interest. Advisors must also be aware of their responsibilities and obligations under IRS Circular 230.
- Before responding to IRS correspondence, gather all the potentially relevant documentation about the donation and assess the risk and exposure to the client.
- Details about the acquisition, purpose, and the appraised value of the donated artwork, and the donor’s interactions with the recipient charitable organization should be discussed.
- To validate the donor’s entitlement to a full fair-market-value charitable deduction, certain crucial documents should be obtained, such as the invoice for the artwork acquisition, correspondences detailing the relationship between art dealers or promoters and the acquisition, and the acknowledgment from the recipient charitable organization.
During the examination process, it is essential to double-check that all relevant forms and documents have been completed correctly and attached to the client’s federal income tax return. Particularly, the appraisal report and IRS Form 8283 should be completed correctly and signed by the donee organization. Other aspects, such as a potential involvement in so-called “dirty dozen” issues, should be gauged here.
Taking into account the attorney-client or work product privileges, it might also be beneficial to engage a second appraiser on a Kovel basis. Potential exposure to any penalty, specifically the 20% or 40% valuation overstatement penalty, should also be evaluated.
Once the situation, risks, and exposure have been comprehensively assessed, the best course of action can be determined. Keep in mind that if the case doesn’t go as planned, recourse to the IRS Office of Independent Appeals or the U.S. Tax Court may be available. In the worst-case scenario, if the case seems futile, it may be best to recommend conceding the case or filing an amended return showing adjustment to the claimed deduction.
This analysis provides valuable insight for tax professionals and legal advisors into how to manage the process of an IRS art donation tax audit and ensure the best possible outcome for their clients.
This analysis was contributed by Brett Gallaway, Lauren Cramer, and John Barrie of McLaughlin & Stern, experts in tax, tax-exempt organizations, litigation, and art law practices.