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.

Here’s what’s due this month:

December 15 – Deposit federal payroll tax for Oct if the monthly rule applies.

December 20 – Texas Sales & Use Tax Return Due.

December 26 – ‘Christmas Day’ observed (federal holiday)

You DO have insurance, DON’T YOU?

The county music duo Sugarland has been named as a defendant in a lawsuit stemming from the collapse of the stage at the Indiana State Fair three months earlier.  The accident, which killed seven and injured another 44, occurred just minutes before the group was set to perform.  Yes, having probably narrowly escaped death, the group finds itself at risk again.

It’s a tragic situation and I’ll leave a discussion of the finer points of negligence theory to the legal scholars.  But I want to highlight the importance of taking steps to adequately protect your business.  This includes liability insurance.

I have run shows both ways: fully insured and sans insurance.  The “commando style” show even featured an aerialist suspended breathtakingly close to the heads of the front row audience.  Everything turned out okay, but promoting a show without the financial safety net of insurance was an unnecessary risk that I’m not exactly proud of… or willing to take again.  Several organizations offer group liability insurance coverage for clowns and other performers at incredibly reasonable rates.  I could not have put on a show at a Six Flags theme park–featuring a half-dozen fire performers, no less–without such insurance.

Yes, I’ve gotten away with it, and maybe you have, too.  But for many professional venues, the lack of insurance is a show stopper.  For that matter, so is a lawsuit.  Insurance won’t ward off lawsuits, but policies can be a talisman against the financial devastation that can follow an unfortunate accident.

photo credit: variationblogr

Auctions are always popular fundraisers with non-profits, and arts organizations are no different in their affinity for this important tool.  However, you should be aware of special deductibility rules when it comes to the donation of rental rights.

Alice owns a vacation beach house which she sometimes rents to the public.  Approached by her favorite arts non-profit, she agrees to donate to their upcoming silent auction the rental of her beach house for one week.  From recent past rentals Alice knows that the fair market value of her donation is $1,200.  Later, at the auction, Bob wins the week in Alice’s beach house with his high bid of $1,500.

Should Alice claim a charitable donation of $1,200 or of $1,500?

Neither, because you cannot deduct a charitable contribution of less than your entire interest in a property.  When you donate the right to use a property for only a specified period of time, you’re donating what’s called a “partial interest” in that property and not the ownership of the property itself.  The Tax Code prohibits claiming a deduction for donations of partial interests in property.  Unfortunately, Alice won’t receive any tax break from her donation.

What about Bob?  Can he claim a charitable donation of $1,500 for his winning bid?

No, he can deduct only $300 of his bid.  As discussed in a previous post, contributions where the donor receives something of value in return for their donation aren’t deductible.  In this case, Bob received the right to use the beach house for a week, a right that is clearly valued at $1,200.  Only to the extent his donation exceeds the fair market value of the benefit he receives can he deduct the excess.  In this case, that excess is $300.

IRS Publication 526 gives plain-language guidance on charitable contributions including which organizations qualify as charitable, which contributions are deductible and which aren’t, important record keeping requirements, and more.

Interesting arts- and artist-related tidbits culled from the Interwebs

• Remember when MTV played music videos? http://ow.ly/7m5i4
• If you don’t know how to connect, relate and communicate with people, there’s little hope for you in becoming profitably creative ow.ly/7l9rd
• Che redux: How to create iconic images in 5 not-so-easy points ow.ly/7l667
• Considering working from home? Ponder this: ow.ly/7r7gx
• Still considering working from home? Set the scene: ow.ly/7r7Mg
• Half-baked? “Content Theft Awareness Week” ow.ly/7l8lp
• A royal flush? Sirius bypasses music royalty org ow.ly/7nGXV
• The word for today is ‘libricide’ ow.ly/7l7Mn
• US Copyright industries NOT losing money to piracy ow.ly/7l6R7

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.

Learn about the IRS Fresh Start Initiative via an informative, one-hour webinar on Wednesday, August 31, at 1pm (CT).

The IRS is helping individual and small business taxpayers get a Fresh Start with their tax liabilities, which includes changes to Collection policy for:

• Lien filing threshold
• Lien withdrawals
• Installment agreements
• Offer in compromise

Register at http://www.irs.gov/businesses/small/article/0,,id=158856,00.html#2

The IRS has, effective July 1, increased the business mileage deduction to 55.5¢ per mile.

In case you didn’t know, you can also claim mileage deductions for three non-business purposes: transportation to and from medical treatment, relocation, and driving done as part of work with or for a charitable organization.

Here’s the breakdown, according to purpose, for both halves of 2011.

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).