For anyone contemplating starting an arts nonprofit, I have drafted a comprehensive guide to qualifying for 501(c)(3) status as an arts organization for the Center for Art Law website, which I will reprint below.
New non-profit organizations often find that the world is not a hospitable place. While innovation, entrepreneurship, and risk-taking by new for-profit companies are lauded, fledgling non-profits typically struggle to gain the acceptance and support of private foundations, donors and others in the non-profit community. There is, after all, only a limited supply of grants and donations to fund charitable, artistic, and educational endeavors. Furthermore, the administrative burden of forming and administering a non-profit can be staggering. New non-profits are therefore often advised to pair up with an existing organization, use a for-profit structure, or explore other alternatives before forming a new entity and applying to qualify under section 501(c)(3) of the Internal Revenue Code (the “Code”).
Despite these challenges, arts organizations share certain traits that can help them thrive as non-profit 501(c)(3) organizations, with fewer of the hurdles faced by other kinds of non-profits. First, while many organizations rely largely on foundation grants and private donations, arts organizations can raise funds from ticket sales to performances, exhibits, and other events. For many kinds of organizations, these “fee-for-service” revenue sources can trigger “unrelated business income tax” or endanger 501(c)(3) status under the “commerciality doctrine” applied by the Internal Revenue Service (“IRS”) and the courts. However, these revenue sources are generally consistent with the tax-exempt status of arts organizations. Additionally, these types of revenue sources can more easily satisfy the “public support” tests that enable an organization to qualify as a public charity, and thereby avoid classification as a private foundation and the stringent oversight to which private foundations are subjected.
The Benefits and Burdens of 501(c)(3) Status
501(c)(3) is a special tax status under federal law, generally available to organizations formed and operated for a charitable, educational, scientific or religious purpose, and promotion of the arts is recognized as a valid educational purpose. Treas. Reg. § 1.501(c)(3)-1(d)(3)(ii), Example 4 (Educational organizations include “[m]useums, zoos, planetariums, symphony orchestras, and other similar organizations,” provided that the organizations otherwise satisfy the requirements of section 501(c)(3) of the Code). However, before embarking on the 501(c)(3) qualification process, it is important to carefully consider whether the benefits of 501(c)(3) status are worth the burdens.
There are three legal benefits to having 501(c)(3) status: (1) the organization’s net revenue (after expenses) is generally not subject to tax; (2) contributions to the organization are eligible for the charitable deduction; and (3) the organization is eligible for grants from private foundations.
These benefits are not quite as advantageous as they may appear. Most non-profits (including arts organizations) do not have large amounts of excess revenue – most struggle to earn enough revenue to pay their expenses. Therefore, the tax exemption on net revenue may not be crucial. Second, while the charitable deduction is a powerful incentive for individuals inclined to give money to non-profit organizations, it is still a difficult task to convince people to give. The charitable deduction tends to be important only when an organization’s Board of Directors has a strong and committed network of high-wealth individuals. Lastly, it can be difficult to get grants from private foundations. Finding grant opportunities takes significant research, and the grant writing process requires preparation, perseverance, and commitment.
Maintaining 501(c)(3) status can also be quite burdensome. A 501(c)(3) organization must be run by a Board of Directors (generally 3 or more people) in accordance with Articles of Incorporation, Bylaws, and various corporate policies that comply with requirements set forth under federal tax law and state non-profit corporation law. In addition, any compensation to Directors or Officers must be closely scrutinized to ensure that such payments are reasonable. And complex tax filings called the Form 990 (or Form 990-EZ) are generally required for organizations with gross revenue exceeding $50,000 per year, and are open to public inspection. (Organizations whose annual gross receipts are normally $50,000 or less, file a much simpler electronic form called the Form 990-N). These and other administrative difficulties are not typically worth the trouble unless 501(c)(3) status would significantly enhance an organization’s fundraising capabilities, or at least its image in the arts community.
Designing a Program of Activities to Qualify under 501(c)(3)
An arts organization that has thoroughly considered the benefits and burdens of 501(c)(3) status and wishes to move forward with the qualification process will need to design a program of activities consistent with 501(c)(3) status. It is important to be aware of which types of activities are acceptable and which activities raise suspicions at the IRS, and be able to show the IRS several bona fide activities that fit squarely within the traditional notions of a 501(c)(3) arts organization.
The exemption under section 501(c)(3) for arts organizations is based on the statutory exemption for “educational” organizations, so educational activities carry significant weight in the approval of 501(c)(3) status. Examples of educational arts organizations include:
An organization formed to promote the advancement of young musical artists by conducting weekly workshops, and sponsoring public concerts by the artists. Rev. Rul. 67-392, 1967-2 C.B. 191.
An organization formed to promote public appreciation of group harmony singing by holding frequent meetings of members where they receive training and instruction in vocal harmony and opportunities to practice under trained supervision. Rev. Rul. 66-46, 1966-1 C.B. 133.
A dance school with a regular faculty, daily comprehensive curriculum, and a regularly enrolled body of students. Rev. Rul. 65-270, 1965-2 C.B. 160.
Educational activities can also include individual instruction, or the dissemination of instructional materials for free or for a nominal charge. See Rev. Rul. 68-71, 1968-1 C.B. 249 (approving the 501(c)(3) status of an organization that provided career education by distributing educational publications at a nominal charge and providing free vocational counseling services).
Public exhibits or performances are also typically valid 501(c)(3) activities, provided that steps are taken to ensure that the selection of artists is disinterested (i.e. the organization is not merely a vehicle for showing the work of founders, directors or other insiders of the organization), and provided that the artists or works are chosen for their artistic merit rather than their ability to appeal to a mass audience. See Plumstead Theatre Soc’y, Inc. v. Comm’r, 74 T.C. 1324, 1332-1333 (1980), aff’d 675 F.2d 244 (9th Cir. 1982) (contrasting commercial theaters, which “choose plays having the greatest mass audience appeal … run the plays so long as they can attract a crowd …[and] … set ticket prices to pay the total costs of production and to return a profit,” with 501(c)(3) theaters, which “fulfill their artistic and community obligations by focusing on the highest possible standards of performance; by serving the community broadly; by developing new and original works; and by providing educational programs and opportunities for new talent.”). It helps if at least some of these exhibits or performances are open to the public for free.
For example, the IRS has approved the 501(c)(3) status of the following organizations:
An organization whose sole activity was sponsoring an annual art exhibit of artists selected by a panel of qualified art experts. Rev. Rul. 66-178, 1966-1 C.B. 138.
A filmmaking organization that organized annual festivals to provide unknown independent filmmakers with opportunities to display their films. Rev. Rul. 75-471, 1975-2 C.B. 207.
An organization that presented public jazz concerts featuring aspiring jazz composers and high school students performing alongside established jazz musicians. Rev. Rul. 65-271, 1965-2 C.B. 161.
A touring repertory theatre company that focused on works that were part of college curricula. Rev. Rul. 64-175, 1964-1 C.B. 185.
Note that the IRS views the exhibition of art much differently than the sale of art, especially with respect to the visual arts. The IRS typically denies 501(c)(3) status to art galleries that engage in the sale of art for a commission. See Rev. Rul. 76-152, 1976-1 CB 151 (rejecting the 501(c)(3) status of a gallery formed to promote modern art trends by exhibiting works of modern artists and selling the works on consignment basis with the artist setting the selling price and the organization keeping a 10% commission, even though this commission was lower than that charged by commercial entities and the gallery planned to supplement its revenue through donations); Rev. Rul. 71-395, 1971-2 CB 228 (rejecting the 501(c)(3) status of a gallery formed and operated by approximately 50 artists for the purpose of exhibiting and selling the work of the founders).
Gallery sales activities are permitted only under very limited circumstances when sales activities are sufficiently minor in comparison to educational and other valid 501(c)(3) activities. Goldsboro Art League, Inc. v. Comm’r, 75 T.C. 337 (1980) (approving the 501(c)(3) status of a gallery that engaged in some sales for commissions in addition to educational activities, based on the following factors: (1) there were no other museums or galleries in the area, thus, the exhibition of art works showed a purpose primarily to educate rather than to sell and the selling activity served merely as an incentive to attract artists to exhibit their work; (2) works were selected by an independent jury for their representation of modern trends rather than salability; (3) the organization demonstrated that educational activities were its priority; (4) the art sales were not conducted at a profit; and (5) of more than 100 works of arts exhibited in the organization’s galleries, only 2 members of the organization had their art exhibited).
Most 501(c)(3) arts organizations focus predominantly on education and/or public exhibits or performances, but other types of activities can be acceptable as well. For example, the awarding of grants to aspiring artists and students is a permissible 501(c)(3) activity, provided that procedures ensuring disinterested selection of winners are developed and scrupulously followed. See Rev. Rul. 66-103, 1966-1 C.B. 134 (approving the 501(c)(3) status of organization formed for the purpose of making grants available to writers, composers, painters, sculptors, and scholars for projects in their respective fields which they would not otherwise be able to undertake or finish due to the lack of funds. In awarding grants, preference was given to persons showing distinction or promise in their respective fields, and the recipients promised to make their work available for the benefit of the public in ways customary and appropriate to the particular work. The organization received no financial benefit from these grants).
The IRS has also approved of activities promoting the appreciation of art by less traditional means, such as the recording and sale of obscure classical music pieces to educational institutions, Rev. Rul. 79-369, 1979-2 C.B. 226, and a museum’s sale of greeting cards displaying printed reproductions of selected works from the museum’s collection and from other art collections. Rev. Rul. 73-104, 1973-1 C.B. 263. However, these types of non-traditional promotional activities should be approached with caution, as they implicate difficult issues that can lead to unpredictable results from the IRS. See e.g. Rev. Rul. 76-206, 1976-1 C.B. 154 (rejecting the 501(c)(3) status of an organization formed to generate community interest in classical music by urging the public to support the classical music program of a for-profit radio station).
In summary, when applying for 501(c)(3) status, an arts organization should be prepared to describe several activities similar to those approved by the IRS. There should be at least some educational component, whether through workshops, classes, online publications or tutorials, or other means. It is helpful to show engagement with the public or local community through free exhibits or performances, and to focus on art that lacks mainstream commercial viability. Lastly, an organization founded or run by artists should make sure to focus on a wide variety of artists rather than just its founders or members.This entry was posted in 501(c)(3), Arts Organizations, Form 1023, Form 1023-EZ and tagged 501(c)(3), nonprofit attorney, nonprofit law, private foundations, social entrepreneurship, tax-exempt organizations. Bookmark the permalink. ← Who Should (and Should Not) File the Form 1023-EZ? Five Habits to Avoid Nonprofit Legal Disasters →