New York Seeks Art Tax Whistleblowers

[This article first appeared on Art Daily  written by Joseph Gentile & Gregory Krakower]

According to famed economist Nouriel Roubini, “While art looks as if it is all about beauty, as a business it is full of shady stuff.”

The global art market is estimated to be valued at up to $70 billion per year in transactions. The opaque and unregulated nature of this market makes it particularly susceptible to fraudulent activity, including tax frauds.

Tax frauds involving art come in many different flavors. Given New York’s prominence in the art world, many of these scams victimize State and City residents by illegally avoiding sales, use and income taxes.

Sales and use tax scams by art collectors and galleries are particularly rampant. People who hang art in their New York homes must pay New York sales taxes when they purchase art in New York, or New York “use taxes” when they display or store art in New York that they bought elsewhere.

However, many people — sometimes in collusion with New York galleries — buy art from New York galleries without paying New York sales taxes. They do so by shipping the art to out-of-state locations, only to quickly roundtrip the art back to New York for display or storage without paying New York use taxes. This is illegal.

Another more brazen variation of this scheme occurs when galleries or art shippers create fake shipping invoices and/or ship empty “tax boxes” out-of-state while the art is quietly delivered to adorn a New York apartment.

And a third sales tax scheme is when buyers claim to purchase art for ”resale,” which qualifies the buyer for a tax exemption, but enjoys the art in his or her home or office after the purchase. New York law is clear: art that is displayed, such as in the home or office of an art collector, cannot be a tax-exempt art purchase for “resale.”

Income tax scams in connection with art can be a problem as well. Many people who maintain a pied à terre in Manhattan carefully avoid staying in New York for more than 184 days to avoid New York resident income taxes. Fair enough. However, they then ignore New York’s requirements to pay “non-resident” income taxes when selling art that has been displayed in those apartments, thinking that as non-residents they won’t be caught.

Unfortunately, some readers of this article — especially those that work with galleries, auction houses, wealthy private collectors, and art shippers — find themselves in the unenviable position of witnessing or being asked to participate in tax frauds related to art transactions. Most will want to do the right thing and report it, but will be understandably concerned about the effect of doing so on their careers.

Rest assured: New York’s whistleblower law not only protects people who report art tax-scams, but also — and here’s the most important part — rewards them. The New York False Claims Act (NYFCA) provides stiff penalties for tax violators and can result in art tax whistleblowers receiving substantial financial rewards when (1) the taxes avoided exceed $350,000 and (2) the cheaters have a net income (or sales) over $1 million. In those cases, tax whistleblowers are generally entitled to 15%-30% of the amount New York authorities recover because of a whistleblowers’ decision to report a tax fraud. And the law has a long 10 year statute of limitations, meaning whistleblowers employed or formerly employed by art dealers have time to come forward. But waiting to report a fraud is not recommended since only the first person who reports the fraud is usually entitled to the financial reward.

The NYFCA also takes into account that retaliation is a legitimate fear harbored by employees and industry insiders as they weigh the possibility of reporting tax frauds. That’s why it has specific anti-retaliation provisions. Those provisions protect employees and former employees from being fired, harassed, discriminated against or otherwise harmed because they came forward and reported tax frauds. The law also prevents prospective employers from refusing to hire whistleblowers. Additionally, and critically, tax whistleblowers can often employ legal strategies to remain anonymous even after they are paid rewards.

In recent years, the New York Attorney General’s office, which oversees the NYFCA, has recently exposed a string of art tax scams, including obtaining multi-million settlements from art collectors and dealers for sales and use tax frauds. None of these have reportedly involved whistleblowers, but whistleblowers have been rewarded for reporting sales-tax frauds in other areas, including a $63 million payment to a whistleblower that reported a sales-tax fraud by Sprint-Nextel.

This is a complex area of law and the decisions people make in the face of illegal behavior —whether to act or not — can have a tremendous career and life impact. Given the weight and complexity of the dilemma, it is prudent to consult with an attorney who regularly handles these types of cases and has experience working with whistleblowers and government prosecutors before taking action. Most attorneys take these cases on a contingency basis which means clients don’t pay any fees unless the case is successful.

As states and cities across the country are suffering financially, it is more important than ever that tax whistleblowers speak up. New York — home to the most important art market in the world — has given insiders in the art world an incentive to speak up, and tax cheats in the art world a reason to worry.

Joseph Gentile is an attorney who represents whistleblowers. He has represented whistleblowers in cases that have recovered over a billion dollars.

Gregory M. Krakower is an attorney who represents whistleblowers. He is the former Sr. Advisor & Counselor to the New York Attorney General, and authored the tax provisions and implementing regulations of the New York False Claims Act. He has taught Whistleblower Law at Cardozo and Cornell Law Schools.