Scheme involves inflating value of donated works to claim bigger tax deductions

by Daniel Grant

24 November 2023

The Internal Revenue Service (IRS) is targeting promoters of schemes that inflate the value of art donated to museums in order to increase charitable deductions that taxpayers may claim. According to a public notice issued by the federal agency on 5 October, a growing number of high-net-worth collectors have been approached by people who offer them opportunities to purchase art described as undervalued or discounted, which then could be donated to non-profit institutions and given a much higher value in a tax filing, allowing them to substantially reduce their overall tax liability.

The IRS revealed in its notice that “more than 60 taxpayer audits have been completed with more in the works” and that those audits have produced more than $5m in additional tax revenues from owed tax payments and fines of people who have fallen victim to these schemes. There is no one type of promoter of these schemes, an IRS spokesperson says, noting that they have included “art dealers and consultants, appraisers, donee organisations, artists, attorneys and other interested parties”. The spokesperson adds that “many of the identified participants in these schemes are new to the art world”.

They are not only new to the art world, but less knowledgeable about the process of donating valuable objects to museums and claiming charitable deductions on their tax returns. New York lawyer and art adviser Ralph Lerner believes that those who have submitted overvalued estimates of works that they have purchased and donated are “maybe at the lower end of the art valuation scale, say items under $100,000”. He adds, “I have not seen nor heard of any such scheme or promotions. An individual would have to be pretty dumb to believe any of it.”

One person who believes that she was targeted indirectly by one such promoter is Los Angeles lawyer Melissa A. Passman, who claims that someone representing an artist in California contacted her within the past year. “I first assumed that the person wanted me to provide legal services,” she says. “Instead, he wanted me to promote a donation scheme to my clients.” She was asked to act as an investment adviser to her art collector clients, recommending that they “buy into the work” of a modestly known artist at a low initial price that was destined to increase significantly and quickly. The promoter “greatly inflated the value of this artist’s work, which I realised when I checked secondary market sales results”. However, the promoter of this scheme “represented that an appraisal would support values in the mid-six figures and that there were several identified museums that would accept the donation”. After a time, she stopped taking the promoter’s calls, which eventually trailed off.

Just say ‘no’

A New York lawyer, Pamela L. Grutman, also heard of these schemes through clients who had been approached. “On occasion, a client has mentioned that they have access to an undervalued artwork and wish to donate the artwork at a later time for the tax benefits,” she says. “When this has happened, I then review the facts of the specific transaction and provide a risk assessment.” She usually counsels them to refrain.

Under current IRS rules, donors of objects must wait at least a year and a day to gift them to non-profit institutions like art museums if they seek to claim an income tax deduction based on the piece’s fair market value, as determined by a qualified appraiser. Less than a year and a day, the IRS will only allow a deduction of the cost value of the item—what the donor actually paid.

According to John Geantasio, a certified public accountant in New Jersey, the pitch works this way: “A promoter might approach the collector with a proposal to have the artwork appraised by a specific appraiser who is known to provide inflated values. The promoter assures the collector that after holding the artwork for just over a year, they can donate it and claim a tax deduction based on the new, inflated value, which might be several times the original purchase price.”

The IRS’ warning to taxpayers states that they “should remember they are always responsible for the accuracy of information reported on their tax return. Participating in an illegal scheme to avoid paying taxes can result in repayments of the taxes owed with penalties and interest and potentially even fines and imprisonment.”