Art Deduction Scams Targeted in IRS Crackdown on Rich Tax Cheats

The next step in the IRS’s crackdown on wealthy tax cheats is going after inflated art valuations that produce outsized deductions.

The IRS has added improper art write-offs to its annually updated “dirty dozen” list of common scams, spotlighting an uptick in those deductions as tax avoidance.

The increased scrutiny on art donations also stems from the IRS having more resources thanks to the tens of billions in funding from the 2022 tax-and-climate law. Those enforcement efforts also seem to coincide with a global art market slowdown. Global sales fell 4% to $65 billion in 2023, a break from two years of growth, according to a 2024 Art Basel and UBS report.

“The IRS is sending a message out to taxpayers that it’s OK to donate art and appreciated property to charity, but just be careful its only purpose isn’t to avoid tax,” said Megan Brackney, a tax controversy partner at Kostelanetz LLP.

People who donate art can deduct its value from their taxes. But the IRS cautioned in its dirty dozen list that “promoters” sell people discounted art, promise it’s worth more, then encourage them to donate it after holding it for a year. Taxpayers then deduct the inflated valuation from their tax bill.

The IRS said in October 2023 it had completed more than 60 audits involving art valuations that produced more than $5 million in additional tax at the time.

Art Schemes Come Into Focus

Tax avoidance involving exaggerated valuations have long been on the IRS’s radar, but the emphasis on these improper art deductions is possible in part because of the tax-and-climate law funds, said Melissa Wiley, a tax controversy partner at Lowenstein Sandler LLP.

Before that funding, the IRS didn’t have the expertise to work on these cases. That’s changing as the agency increases enforcement efforts.

“The IRS is heavily recruiting people from the private sector,” Wiley said. “I can only assume they’re asking people what’s going on out there.”

The IRS has a team of appraisers that assists the agency when it conducts enforcement matters, and it sometimes refers high-value art works to an advisory panel. The IRS art advisory panel recommended decreasing the value of about a third of the art pieces it evaluated in fiscal year 2022, according to its most recent annual report.

People who inherited art and don’t know much about it may get caught up in this type of promoter scheme, Brackney said.

This scam may have become more popular because the 2017 tax law eliminated many individual deductions, such as the $10,000 cap on state and local deductions and limited the casualty and theft loss deduction.

“When that happens, people are inspired to find ‘creative ways’ to reduce their tax,” Brackney said.

These art transactions have the same structure as certain conservation easements, which the IRS has long targeted in the courts. Essentially, people put conservation easements on their land to receive a tax deduction, but the IRS feels the land is not worth the amount the taxpayer used for the deduction.

“Any time there’s movement of an asset that’s difficult to value, that’s ripe for dispute with the IRS,” Wiley said.

The IRS also has tightened its valuation standards generally in the past year, said Michael Kosnitzky, co-chair of the private client and family office practice at Pillsbury Winthrop Shaw Pittman LLP.

The agency may throw out appraisals that it deems invalid, regardless of the valuation. For example, the agency may take issue with appraisals when it perceives a conflict of interest for the appraiser or because the appraiser’s qualifications weren’t listed in the report.

“Valuations are being challenged as to whether or not the reports themselves are valid,” Kosnitzky said.

Avoiding Art Deduction Scams

Tax professionals are advising their clients about how to prevent the IRS from challenging their art donations and slapping them with high penalties. In particular, they’re warning taxpayers against taking the advice of promoters who make lofty promises.

“If somebody else tries to tell you what to do and it just seems too easy, or too good to be true, don’t do it,” Wiley said.

The IRS will review an appraisal for a $7,500 fee before a taxpayer files their return.

If a taxpayer gets involved in an art donation scheme, they face higher penalties for a “gross valuation misstatement,” Brackney said. The IRS adds a 40% penalty to the taxes owed if the valuation claim is 200% more than the actual value.

“Congress’s message is that if you’re donating to charity, you have to be correct on the valuation or you’re going to end up with penalties,” Brackney said. “That’s an acknowledgment these types of things have been happening for a long time.”

The promoter who got a taxpayer into an art-donation scheme may face no penalties. The lengthy audit process makes it difficult for a taxpayer to sue the promoter, either because they’re hard to find again or because of the statute of limitations, Brackney said. But the IRS can open investigations into promoters.

“I haven’t seen one yet, but I wouldn’t be surprised if they’re doing that here,” she said.