May 1996

Where does charity stop and commerce begin at US museums?

A legal review of the regulations governing non-profit institutions

IRS Building, Washington, DC Photo: TravelingOtter on Flickr

IRS Building, Washington, DC Photo: TravelingOtter on Flickr

The relationship between institutions with charitable and educational purposes, and the government or monarch, has always been fraught with tension, especially over economic matters. In the 16th century, the Church, the oldest and perhaps the most successful institution of this kind, is said to have owned one-fifth of the land in England. Eventually, the political and economic power this engendered, led Henry VIII to dissolve the monasteries and confiscate much church property.

Governments have always had to weigh the social benefits provided by charitable and educational institutions against the possibility for abuse that arises when their high moral purposes become, or appear to become, compromised by less altruistic aspirations.

Today, nowhere in the world is the private non-profit sector more developed than in the US, where tax exempt charitable institutions account for 11% of the GNP. So for decades, the US has faced the question of the extent to which these institutions should be allowed to engage in revenue-generating activities in order to finance their ultimate charitable purpose.

Carolyn Clark and John Sare, lawyers at Milbank, Tweed, Hadley & McCloy in New York, recently gave a paper, at the International Bar Association conference on Museums in the Global Economic Environment, outlining how the US government has approached these issues.

In the US, direct government support of the arts is minimal, by comparison with Europe. However, the government indirectly encourages the arts through its tax structure, which is designed to encourage private responses to public needs. It is this structure that justifies wider tax exemptions and more revenue-generating activity than one typically finds in Europe. But as European governments try to reduce spending, and in particular subsidies, revenue-generating methods of US museums, colleges and other institutions and the related regulation is of considerable interest to similar European institutions.

The US exemption from income tax is valuable for at least two reasons. Firstly, it permits museums to avoid corporate income tax. Secondly, it allows museum donors to receive tax deductions for their contributions.

How does a museum qualify for this exemption in the US?

A variety of standards must be met, but perhaps most significantly, when considering revenue-generating activities, a US museum must demonstrate to the Internal Revenue Service that it is organised and operated “exclusively” for charitable purposes. This standard is fulfilled if a museum engages “primarily in activities which accomplish one or more” of its charitable or educational purposes.

Yet a tax-exempt museum may nonetheless engage in some activities that are taxable. For museums that are contemplating revenue-generating activities, the question is whether—and to what extent—they can structure their activities to avoid this tax, known as the Unrelated Business Income Tax, or “UBIT”. The tax is assessed on a museum’s net income from an activity that is a trade or business, is regularly carried on by the museum, and is unrelated to the museum’s charitable and educational purposes.

In order to see the limits of a museum’s tax liability it is useful to look more closely at the components of UBIT.

An activity is not a trade or business simply because it produces profit. Rather, it must be carried on with a profit motive and in a competitive manner, similar to the way a corporation would conduct the same activity.

A major issue in the USA has been whether the recognition that museums and other institutions give to “corporate sponsors” is in the nature of the business of “advertising”. After years of debate, the US Congress seems close to enacting a new law that would define what is and is not an “advertisement” for these purposes. Under the current legislative proposal, museums would be able (tax free) to acknowledge the name, logo and product lines of a donor, so long as there is no “advertisement”. An “advertisement” would be defined as messages containing “qualitative or comparative language, price information or other indications of savings or value, and endorsement, or an inducement to purchase, sell, or use such products or services”. A US Senate report states that display or distribution of a donor’s product on the museum’s premises at a sponsored event would not be an “advertisement”.

Single short transactions generally escape UBIT because they are not deemed to be regularly carried on by the museum.

An activity is unrelated if it is not “substantially” related to the museum’s charitable purposes. This concept is construed to mean that the activity escapes UBIT only if it “contributes importantly” to the purposes. The interpretation has been expansive: ties and scarves “inspired by” textile designs in a museum’s collections, often accompanied by a slip of paper explaining their art historical sources are treated as “related”. However, museum organised travel tours in many cases have been found by US auditors to be more like vacations than education. Careful structuring of such programmes is essential to avoid UBIT.

Many activities escape UBIT because of express statutory exceptions for income from rents, royalties, dividends and capital gains. These exclusions are narrowly interpreted by the IRS. For example, although the term “royalties” clearly includes revenue from a trademark or copyright licence, the IRS contends that a charitable organisation that licenses its mailing list (often a very valuable asset) is really providing a personal service to the licensee and that the income is not a “royalty” and hence is taxable.

As UBIT only applies to net income from an activity (gross receipts less gross expenses, including an allocable share of overhead), the resulting tax is often relatively modest. Wholly-owned (but taxable) subsidiaries can be created, but less flexibility in overhead allocations may result in higher net income—and thus may make subsidiaries an economically unappealing option.

Nonetheless, if an activity is highly lucrative, its ongoing conduct may call into question whether a museum is actually operating for “exclusively” charitable and educational purposes. It is in this (as yet rare) circumstance—when a US museum concludes that its economic success may jeopardize its tax-exempt status—that it is most likely to create a subsidiary.

As four fifths of the income of US charities is self-engendered (not donated), these rules shape much of museums’ revenue raising activities. Whether the US government has got these rules right is the subject of much debate, not least among US businesses that feel that museums have an unfair competitive advantage. As European governments consider alternative ways to fund cultural institutions, critics of the US system will undoubtedly ask whether the latitude of the US rules allows too much deviation from the higher social purposes that museums and other institutions are designed to support. Whatever result is achieved it is certain that the economic independence of cultural institutions will be fiscally attractive to governments, but will always be fraught with social, economic and political considerations.

• Originally appeared in The Art Newspaper with the headline "Museums: where does charity stop and commerce begin?"


We use cookies to personalise content and ads, to provide social media features and to analyse our traffic. We also share information about your use of our site with our social media, advertising and analytics partners who may combine it with other information that you’ve provided to them or that they’ve collected from your use of their services. Read our Cookie Policy for more information.