Dear Rex,
I’ve formed an arts organization and serve as an officer.  The org has applied for tax exempt status.  I paid out of my own pocket both the filing fee to form the corporation and the application fee to file the Form 1023.  Assuming the IRS approves our tax exempt application, can the organization reimburse me for these costs without either of us getting in trouble?
—Nervous Newbie

Dear Nervous,

As I described in another recent Q&A, the IRS has very specific rules that prohibit transactions between an exempt organization and the people (called disqualified persons) who exert control over the operation of that organization.  The payment of compensation or the reimbursement of expenses by an exempt organization to a disqualified person constitutes one of these prohibited transactions.  [Internal Revenue Code 4941(d)(1)(D)]

However, volunteers of an exemption organization, including officers, may receive reimbursement or an allowance for out-of-pocket expenses, so long as such expenses are reasonable and necessary to carrying out the exempt purpose of the foundation and the payment is not excessive.  [Generally, IRS Guide and specifically, IRC 4941(d)(2)(E)]

The expenses you described—called organization costs—are only incurred during the organization’s formation.  Are they still eligible for reimbursement?  Yes.  The IRS recognizes organizational costs as legitimate business expenses.  Similar costs include:

• State incorporation fees
• The cost of legal services incident to the creation of the organization
• Accounting fees for services incident to the creation of the organization
• Filing fees

[IRS Publication 535]

So no need to be nervous about receiving reimbursement for the out-of-pocket expenses you incurred in creating your organization.

Dear Rex,
Our arts organization is waiting on some big donations promised to arrive in January of the new year.  But we’ve got some expenses due in December and not enough money in the bank to pay them all.  Can I make a short-term loan to our organization to cover these expenses and have the organization repay me when the donations are made?  If so, how would it affect my personal taxes and the org’s taxes?  And if the org is unable to repay me, would the loan become a donation or just a bad debt loss?
—Board President

Dear Board President,

Exempt organizations receive their special tax treatment to promote and encourage public support of the charitable purposes around which they were organized.  To ensure a few private individuals don’t take advantage of something intended to benefit the public, exempt organization are subject to special rules that prohibit selfish activity.

One such rule is the prohibition against “self-dealing” transactions between an exempt organization and a disqualified person.  Self-dealing transactions include the sale, exchange, or leasing of property; the lending of money or other extension of credit; the furnishing of goods, services, or facilities; the payment of compensation (or payment or reimbursement of expenses); and the transfer or use of the income or assets of the organization.  [Internal Revenue Code Sec. 4941 (d)(1)]

Who is a disqualified person?  Simply put, substantial contributors, foundation managers, and family members of both.  If substantial contributors are themselves organizations, then the owners of more than 20 percent interest of that organization are also considered disqualified. A foundation manager is an officer, director, trustee, or a person having similar responsibilities whether specifically so designated on an official document (like the certificate of incorporation, or bylaws) or if he or she regularly exercises general authority to make administrative or policy decisions on behalf of the organization.  [Internal Revenue Manual 7.27.20]

To recap your particular situation, you are an officer of an exempt organization (a disqualified person) who wishes to loan money to that organization (a prohibited self-dealing transaction).

So this transaction is clearly not allowed, right?  Not so fast.

There is a legal exemption that states the prohibition against a self-dealing loan “shall not apply to the lending of money or other extension of credit by a disqualified person to a private foundation if the loan or other extension of credit is without interest or other charge.”  [emphasis added, 26 CFR 53.4941(d)-2(c)(2)]

As long as (a) you are lending money to the organization and not the other way around, and (b) you are charging no interest on your loan, your loan would be allowed.

If you decide to make this loan, you’ll want to put the loan in writing.  I’d have the full board vote on the loan while you abstain from voting.  The board should, of course, record its decision in the meeting minutes.

For accounting purposes, you would show on your personal books a loan due to you (“notes receivable”); the organization would show that it owed a loan (“notes payable”) in the same amount.  Because the transaction is a loan, rather than a donation, and no interest is being charged, there are no tax consequences for either you or the organization.

If the organization is does not repay the loan, the tax treatment becomes trickier.  The IRS will look at the facts and circumstances of the situation—especially the organization’s financial ability to repay the loan—to determine your “charitable intent” in writing off the loan.  Let’s hope for the best and assume, if this happens, you’ll call in a tax professional to guide you through the process.

The rules around self-dealing and disqualified persons are much more complex and nuanced than I’ve described here.  If your situation doesn’t exactly match the one described above, you owe it to yourself and your exempt organization to get good advice that fits your unique situation.

Dear Rex,
Our arts organization is holding a fundraiser and selling tickets for $30 each.  How much of that ticket can a donor claim as a tax deductible contribution to our organization?
—Happy Feet

Dear Happy Feet,

To the extent that the donor (ticket buyer) receives something of value in return for their contribution, the part of the donation (the amount of value received) would not be deductible.

You should determine in advance the fair market value of the goods or services the ticket buyers might receive (for example, the value of dinner served, gift baskets given, etc.) and notify your potential donors of such when you publicize the fundraising event.

At the fundraiser, we plan on holding a silent auction. If an auction item is valued is $1,000 and sells for $700, how much is deductible? What if the same item sells for $1,500?

Again, the value received by the donor in exchange for such donation is what determines how much is of the donation is deductible.

Scenario A: Valued at $1,000, sold for $700. Purchaser gets a written acknowledgement of the good faith estimate of the art ($1,000 dollars). Because the donation is less than the value received, the donation is not tax deductible.

Scenario B: Valued at $1,000, sold for $1,500. Purchaser gets a written acknowledgement of the good faith estimate of the art ($1,000 dollars). The portion of the donation that is more than the value received ($500) is tax deductible.

In both cases, since the donation (purchase of art) is greater than $250, the non-profit must provide a written acknowledgement of both the donation and the value of the goods/services provided by the organization.

More information on good faith estimates and disclosure requirements for non-profits can be found in IRS Publication 557 or on the Charities and Nonprofits homepage of the IRS website.

Dear Rex,
We’re both an arts studio (teaching classes) and theatre company (putting on performances) and were wondering if we were subject to Texas state sales tax with these two things?
-Windy

Dear Windy,

When you sell tickets to performances, those sales are clearly taxable as “amusement services” under Texas Administrative Code Rule §3.298(a)(1)(A). You, rather than the venue, would be responsible for remitting the sales tax to the Comptroller’s office under §3.298(i)(2) unless the venue specifically agreed in writing to be responsible for remitting taxes on your behalf.

If you are a non-profit, however, there is an exemption that may apply to you. Rule §3.298(g)(1)(A) says that sales tax is not due on an amusement service if the service is provided exclusively by a nonprofit organization, corporation, or association, including those exempt under Internal Revenue Code of 1986, §501(c)(3), so long as the proceeds do not go to the benefit of an individual.

However, the classes you teach are not taxable. When the activities are “primarily instructional in nature” they are are considered “nonamusement services” and exempt from sales tax under Rule §3.298(a)(2).

Dear Rex,
If a working artist in the state of Texas sells some of his pieces, but it isn’t a significant portion of his income, should he still collect sales tax on the pieces sold? And how does he go about filing said taxes with the county and/or state? (Or is there a ballpark threshold income above which it would be wise for said artist to file such paperwork?)
-Taxes in Texas

Dear Taxes,

Pony up, buddy; if you’re selling more than two pieces of your art in a 12 month period—and congrats if you are—you have a legal obligation to collect sales taxes and send them to the State.  Unlike the Margin Tax (which is applicable only to corporations, limited liability companies, and the like), there is no minimum threshold for Sales Tax so you owe tax starting with the first dollar in sales.

The first step is to apply for a sales tax permit with the Comptroller of Public Accounts.   You can do this on-line here.  Before you visit, you’ll need:

• Sole owners need a social security number.
• Partnerships need the social security number or federal employer’s identification number for each partner.
• Texas corporations must have their file number from the Texas Secretary of State.
• All corporations need the social security number for each officer or director.

After your application is approved, it’ll take 2-3 weeks to receive your permit in the mail.

Once received, you’ll need to file and pay your taxes on a schedule determined by your sales volume.  In other words, you’ll file either monthly, quarterly, or annually, as outlined in the instruction sheet that will accompany your permit.  Filing and paying is pretty easy, too, and can also be done on-line.  If you have zero sales in a tax period, remember that you still need to file a return.  There are penalties if you fail to file a return, even when no sales tax is due!

The tax rate you’ll charge is based on the location of your studio, shop, or office, and is composed of city, county, and state taxes.  In larger cities like Houston and Austin, this combined rate adds up to 8.25%.  The State provides information with your permit to help determine the rate.  The good news is you pay the entire tax bill to the state, who then handles divvying the money between the different jurisdictions.

By the way, the Controller’s office is staffed with very helpful people who do a good job of answering your questions either on-line or in person at their state-wide office locations.

Dear Rex
I’m traveling to SXSW in Austin for business, and my spouse is accompanying me so we spend a day or two vacationing. How much of my trip is tax deductable?
-Creative Vacationer

Dear Vacationer,

Travel expenses include the cost of transportation by airplane, train, bus, or car; baggage and shipping; lodging and meals; dry cleaning and laundry; and tips on such costs.

You can deduct all of your travel expenses if your trip was entirely business related.

If your trip was primarily for business and, while at your business destination, you extended your stay for a vacation, made a personal side trip, or had other personal activities, you can deduct your business-related travel expenses. These expenses include the travel costs of getting to and from your business destination and any business-related expenses at your business destination.

For example: You and your spouse fly to Austin. You attend the conference during the day, your spouse doesn’t. The conference lasts 5 days and you stay the weekend, then fly home. Your plane ticket (business related) is fully deductable, your spouse’s ticket (vacation) isn’t. Of your hotel bill, the 4 nights that covered the conference are deductable, the 2 weekend nights aren’t.  Assuming you rented a car the entire time, 4 of the 6 rental days would be deductible.

The rules are a little different for travel outside of the United States.  You can read more at the IRS website.

Dear Rex,

I’m a self-employed musician and pay for my own health insurance.  How much of this can I deduct?

–Healthy Artist

You may be able to deduct premiums paid for medical and dental insurance and qualified long-term care insurance for you, your spouse, and your dependents.  To qualify, you must be a self-employed individual with a net profit reported on Schedule C (Form 1040), Profit or Loss From Business, Schedule C-EZ (Form 1040), Net Profit From Business.

The insurance plan must be established under your business.  For Schedule C filers, the policy can be either in the name of the business or in the name of the individual.  However, you cannot take the deduction for any month you were eligible to participate in any employer (including your spouse’s) subsidized health plan at any time during that month.

Dear Rex,

I’m an artist and I use my car for all kinds of business purposes.  What can I “pay for” through my business towards travel, and what deductions should I be tracking for tax purposes?

–Wandering Artist

Dear Wandering,

The travel expense deduction gets extra scrutiny from the IRS because it’s so prone to being abused.  Business use of a personal car even has special record keeping rules.  If you own only one car, logic dictates that some of the miles you put on it in a year must be for personal reasons: your daily commute (if you’re an employee) and trips to the mall, grocery store, movie theatre, and the like aren’t eligible for deduction.  So to be able to claim any auto-related expenses, you must keep track of how many of the miles you’ve driven were for business and how many were personal.

The most commonly accepted documentation is a written mileage log.  Here’s the most painless way to use it.  Stash the log and two pens (in case the first pen runs out) in your glove box or center console.  On  January 1, write down your mileage.  Every time you finish a business drive, note the date, the number of miles driven, and the business-related purpose of the trip.  Don’t worry about tracking your personal use miles; only track the business trips.  On December 31, write down your mileage again.  By subtracting your starting mileage from your ending miles, you’ll get total miles driven in the year.  Add up the miles driven from each business trip and subtract that number from the total miles to get your personal miles driven.

By the way, the standard mileage rate for business driving dropped from 55¢ per mile to 50¢ per mile, effective January 1, 2010.