IRS Defines the Role of the Artist
The IRS updated its Audit Technique Guide for artists and art galleries last Friday to provide definitions of artists and art galleries, and identify potential audit issues and charitable donation issues, according to an email sent Friday to tax professionals.
Actually the definition of artist still seems somewhat murky, but the IRS does have this to say: “The creative process of the artist is constantly expanding the definition of what is a piece of artwork. The medium through which an artist works is likewise expanding. An artist’s work, during their life and later, may sell numerous times and be seen in galleries more than once. The sales value can vary fr om a small sum to millions of dollars such as with the work of Picasso, Van Gogh, etc. An artist may achieve notoriety during their life or may never achieve it; however, their works are of no less importance.”
Despite these profound sentiments, the IRS is not likely to have the opportunity to audit either Van Gogh or Picasso. However, IRS employees could well be auditing artists, as it has noted that the art world is frequently a cash business.
“It is difficult to monitor compliance with the tax laws by artists because art galleries are not required to report sales via information returns (Form 1099), whether they sell the art on a consignment basis, or carry inventory because as a retail establishment they are exempt from the reporting requirements of IRC Section 2041 for property,” the IRS noted. “Additionally, some artists prefer to use cash for personal living expenses and often deal in cash that makes gross income probes of artists challenging for any examiner. The examination of an art gallery will often provide related cases for unreported income of an artist on their return.”
As the IRS wryly noted, trying to make a living as an artist is not necessarily a for-profit business. “An artist may conduct their craft as their occupation as a for-profit trade or business or as a not for profit activity,” it said.
The IRS thus devotes much of its Audit Technique Guide to audits of art galleries, typically a much more lucrative endeavor than actually creating a work of art.
“Gallery owners are the key to the business,” said the IRS. “Some are experienced artists themselves, while others are collectors turned salespeople, or merely entrepreneurs seeking profits. However, the more knowledgeable the gallery owner is about the artwork, the clientele, and the market, the better the business will function. Galleries with similar art, prices, and location will succeed or fail, and the determining factor appears to be the owner of the business and his or her working knowledge of the industry. This one factor seems to determine the overall strength of the gallery.”
The IRS pointed out that galleries can vary greatly in size and revenue. “Some galleries hold vast inventories of over $40 million, while others only take works of art on consignment, wh ere the gallery sells the art for a commission but ownership remains with the artist until sold,” said the IRS.
The books and records found in galleries are the basic ones found in any industry since galleries use general ledgers and general journals, the IRS noted.
“Large galleries will probably have all records, such as journals, ledgers, inventory records, and check disbursements in computerized form,” said the IRS. “Some of the smaller galleries may still use manual systems.”
The eventual buyer of a work of art is also of more than passing interest to IRS auditors.
“Once the artwork leaves the hands of the artist, it generally goes to one of four categories of persons, each of which have different tax considerations,” said the IRS. “They are the investor, hobbyist, business collector and dealer. Which category a taxpayer falls into would depend on the facts and circumstances of that taxpayer's case. The line between the above categories of holders of art for tax purposes is not always clear; therefore, there has been much litigation in the courts such as the distinction between investor and dealer or between an investor and a hobbyist.”
In other words, trying to define a taxpayer can be much like trying to define a work of art. It’s all in the eye of the beholder, who could well turn out to be an IRS auditor.