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October 31, 2023
2023-1811

IRS rules private foundation's expenses for acquiring artwork to loan to tax-exempt organizations are qualifying distributions, and artwork's value may be excluded from distributable amount calculation

  • The IRS concluded that expenditures for acquiring artwork to loan to tax-exempt organizations that further the arts are qualifying distributions for purposes of a foundation's annual qualifying distribution requirements.
  • The IRS also concluded that the artwork constitutes assets directly used in carrying out the foundation's exempt purposes, and thus may be excluded from its minimum investment return when calculating its annual qualifying distribution amount.
  • Organizations should keep in mind which expenditures may constitute annual qualifying distributions.

In PLR 202342009, the IRS ruled that pieces of artwork acquired by a private foundation, which are used to carry out the foundation's exempt purpose, are assets that may be excluded from the foundation's minimum investment returns used in determining its required annual distributions under IRC Section 4942(c)(1)(A) and Treas. Reg. Section 53.4942(a)-2(c)(3). In addition, the IRS ruled that the foundation's expenditures to acquire the artworks are qualifying distributions under IRC Section 4942(g)(1).

Facts

The foundation, an IRC Section 501(c)(3) exempt organization and IRC Section 509(a) private foundation, is primarily funded by family members and gives grants to museums and educational institutions that support the arts. Family members want to donate additional artwork from their collection to the foundation, which intends to hold and use the artwork for an educational lending program, not for private use. The foundation will lend this artwork to qualifying tax-exempt public museums, galleries, educational organizations and other similar institutions for public exhibition. The foundation will store the artwork in a room that is designed for this use and owned or leased by the foundation.

Law

To maintain its tax-exempt/private foundation status and avoid incurring excise taxes, a private foundation must annually distribute a minimum distributable amount, which is determined based on its minimum investment returns, with certain adjustments. IRC Section 4942 generally imposes an excise tax on a private foundation's undistributed income — the amount by which the foundation's minimum distributable amount each year exceeds its qualifying distributions for that year.

The minimum investment return generally excludes assets used, or held for use, to further a private foundation's exempt purposes. Under Treas. Reg. Section 53.4942(a)-2(c)(3)(i), an asset fulfills this requirement if it is actually used by the foundation in carrying out its exempt purpose or, if the immediate use of the asset is not practical, then definite plans exist to use the asset within a reasonable period.

Qualifying distributions are amounts paid to accomplish tax-exempt purposes or to acquire assets used (or held for use) directly in carrying out those purposes (IRC Section 4942(g)(1)).

Treas. Reg. Section 53.4942(a)-2(c)(3)(ii)(c) lists works of art owned by a foundation that are on public display as an example of assets used or held for use directly in carrying out a foundation's exempt purpose.

Revenue Ruling 74-498 "holds that a collection of paintings owned by a foundation formed to further the arts, that is loaned under an active loan program for exhibition in museums, universities and similar institutions, is being used directly in carrying out the foundation's exempt purposes within the meaning of [IRC S]ection 4942(e)(1)(A), and the value of the paintings is excluded in computing the foundation's minimum investment return."

Analysis

The IRS concluded that artwork that is owned by the foundation and acquired through donations or purchases will constitute assets used directly in carrying out the foundation's exempt purposes, and therefore may be excluded from the foundation's minimum investment return under IRC Section 4942(e)(1)(A) and Treas. Reg. Section 53.4942(a)-2(c)(3).

The IRS also concluded that the foundation's expenditures to acquire additional art for its lending program will constitute qualifying distributions under IRC Section 4942(g)(1).

In reaching this conclusion, the IRS said:

  • The foundation's role in loaning artwork to tax-exempt organizations, managing the art collection, providing for its exhibition and display, and holding it for exhibition is like the active loan program described in Revenue Ruling 74-498
  • The foundation's expenditures to acquire artwork to loan to tax-exempt organizations would be like those described in Example (3) in Treas. Reg. Section 53.4942(a)-3(a)(7), which constituted qualifying distributions
  • Acquiring additional artwork for exhibition and display to the public furthers the foundation's exempt purposes

Implications

Although this ruling does not break any new ground, it underscores the need for private foundations to carefully track and calculate both their qualifying distributions and the assets included (and excluded) in the minimum investment return used to calculate their required annual qualifying distribution amount, and to be sure that their expenditures further their charitable purposes. A private foundation that collects art, or other assets that it uses to carry out its exempt purposes, may exclude those assets from its minimum investment return.

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Contact Information
For additional information concerning this Alert, please contact:
 
Exempt Organization Tax Services
   • Stephen Clarke (stephen.clarke@ey.com)
   • Morgan Moran (morgan.moran@ey.com)
   • Cal Hoke (cal.hoke@ey.com)

Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor

 

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