‘Jewel-Box’ Museums Are the Wealthy’s Latest Tax Dodge Scheme

Private foundations are increasingly used by the wealthy to garner huge tax deductions and retain control and enjoyment of valuable assets through creation of so-called jewel-box museums.

We’ve talked about the need for increased scrutiny for 501(c)(3) organizations in the political arena. In the hands of rule skirters, these organizations—which the IRS calls private foundations—are something of a Swiss Army knife for questionable behavior. When they aren’t being used to funnel dark money into politics, they make excellent tools of tax avoidance for the mansion class.

As always, increased funding for enforcement is necessary to curtail these abuses. From there, the IRS must establish stricter rules for these types of tax programs and convey that the tax breaks are conditioned on sufficient resources for enforcement.

The Jewel-Box Museum Scheme

The scheme itself works something like this: You purchase an ostentatious mansion or historic property that might contain some art. It’s expensive when you purchase it, and its value skyrockets in the years to follow. You have no interest in selling the property, but you’re sitting on a mountain of value on paper. There must be something you can do to tap into that.

You decide to donate your property to a private foundation that you’d control, entitling you to myriad income tax deductions—at least in theory, if other requirements are met. For example, you’d need to provide some kind of public benefit through the property and the organization, and you couldn’t engage in so-called self-dealing.

But even the most stringent rules are only as stringent as their enforcement, so the deal sounds pretty good. You’d take a massive tax deduction, and the only expenditure you’d have to make would be for a “Sorry, We’re Closed!” sign to hang in the foyer.

Many tax abuses are roll-the-dice schemes—the transaction or plan is in a gray area or outright restricted, but the chance of being caught is so slim that a rational actor would proceed in hopes of falling through the cracks. These quasi-museum and art collection schemes are a quintessential example of this decision-making process.

As with most other enforcement activity, the gutting of IRS funding has reduced the agency’s ability to police the public benefits of private foundations. There simply aren’t enough agents and resources to audit more than a vanishingly small percentage of returns, much less make site visits to ensure these “museums” regularly admit the public.

The ties between tax breaks and enforcement need to be strengthened, both in terms of drafted policy and communication. The highest-level requirement is that the IRS receive more funding to pursue enforcement activities and build out policy to curtail the abuse of private foundations by the wealthy. From there, more specific policy changes can be made to close the loopholes.

Mirror-covered geometric shapes hang in the Building Museum as part of the “Look Here” exhibit on July 6, 2023 in Washington.

Photographer: Anna Moneymaker/Getty Images

Tighter Rules

The rules for what qualifies as a charitable donation to a private foundation must be tightened. Donations such as the one in the example above should require explicit reporting of when and how the property will be open to the public. In the case of a private art collection, the donor should outline how and where the art will be displayed and what steps have been taken to hire staff.

Vague policy benefits only the wily. Requiring a private foundation, for example, to keep a historic property open 20 hours per week, during ordinary business hours, and at a reasonable admission cost would enable random audits for compliance.

Such a rule also would disaggregate enforcement to the public. The IRS generally awards 15% to 30% to whistleblowers who report tax noncompliance. Turning those forces loose on private museums and art collections would keep enforcement costs down.

Not all enforcement can be delegated to the public, and tax authorities would need to undertake audits of impermissible private benefits. The federal tax code restricts what sorts of benefits can accrue to disqualified persons of private foundations.

At a minimum, folks and their families shouldn’t be living in their jewel-box museums on the public dime. In practice, only tax authorities can police those boundaries, which is where increased funding for the IRS comes in.

Greater Transparency

Tax-exempt organizations other than churches must file information returns that outline assets; income; expenses; and compensation for officers, directors, and trustees. The public should know where the tax-exempt entities’ money is going, because the public foots the bill for those exempt taxes.

This disclosure process needs to be expanded to include—in the case of private foundations that provide access to property or works of art—a clear outline of when the items would be publicly available. More broadly, the IRS must define what constitutes a sufficient public benefit in exchange for tax exemption and make those reports accessible to everyone.

Outlook

Efforts to increase tax compliance by the wealthy or raise rates on billionaires will falter as long as there are loopholes and end-arounds that enable top earners to look more like middle-class earners on their tax returns.

The problem is partly an issue of political will, but it also entails political messaging. Tax deductions for donations to private foundations aren’t an entitlement. They’re a benefit, conditioned on sufficient resources to ensure they’re fairly doled out.

Look for Leahey’s column on Bloomberg Tax, and follow him on Mastodon at @andrew@esq.social.