Federal Court Upholds IRS Promoter Penalties Against Art Donation Program Operator Under IRC Section 6700

A federal district court in Texas recently granted summary judgment in favor of the United States in a case involving penalties assessed against the operator of an art donation program that marketed charitable contribution tax deductions based on inflated appraisals and questionable ownership arrangements. The decision reinforces the Internal Revenue Service’s authority to impose substantial promoter penalties under Internal Revenue Code Section 6700 and provides important guidance on what constitutes false or fraudulent statements regarding tax benefits.

Abbey Art Consultants, Inc., a company founded and controlled by David Ehrlich, engaged in the business of acquiring artwork, storing it, and facilitating its donation to charitable organizations so that customers could claim charitable contribution deductions equal to the artworks’ appraised fair market value. Customers typically paid a small deposit, often only five to ten percent of the quoted purchase price, and were told that ownership of the artwork began when pieces were “set aside” for them in storage. Abbey Art then held the artwork for approximately one year before arranging for donation and providing customers with appraisals and prefilled tax documentation claiming deductions significantly higher than the amounts paid for the art.

In 2021, the IRS assessed penalties against Ehrlich under Section 6700 for promoting an abusive tax shelter through false statements concerning the availability of tax benefits. After Ehrlich paid a portion of the penalty and filed a refund suit, the government counterclaimed for additional penalties exceeding $1 million. Following Ehrlich’s death, his estate was substituted as the plaintiff.

The court first addressed the applicable standard of proof for Section 6700 violations. Although many courts apply a preponderance of the evidence standard, the court adopted a clear and convincing evidence standard based on Fifth Circuit precedent and analogous fraud provisions in the Internal Revenue Code. Applying that heightened standard, the court concluded that the government had met its burden on all required elements.

To establish liability under Section 6700(a)(2)(A), the government was required to show that Ehrlich made or caused others to make false or fraudulent statements about material matters relating to tax benefits and that he knew or had reason to know the statements were false. The court found clear and convincing evidence that Ehrlich made material misrepresentations in two primary areas. First, he represented to clients that they acquired ownership of artwork when it was segregated in storage or when a small deposit was paid. Second, he advised clients that they could claim charitable deductions based on appraised values and rely on those appraisals for tax purposes.

The court concluded that customers did not obtain ownership of the artwork when it was merely set aside because clients had no binding obligation to pay the remaining balance and Abbey Art could not enforce payment. Accordingly, the arrangements amounted to options to purchase rather than completed sales. Without a transfer of ownership, the on-year holding period never commenced.

The court also rejected the estate’s argument that client testimony regarding their subjective belief that they owned the art was sufficient to create a factual dispute. The absence of enforceable contracts, the ability to refund or revise deposits, and the lack of client possession or identification of specific artwork supported the conclusion that Ehrlich’s ownership representations were false as a matter of law.

Further, the court found that Ehrlich knew or should have known that his statements were false. He did not rely on advice from tax professionals, exercised full control over the company’s operations, and was a sophisticated businessperson familiar with tax matters. Importantly, Ehrlich was aware of prior court decisions rejecting similar Abbey Art arrangements, which directly undermined his representations regarding ownership and holding periods. The court also held that statements made by Abbey Art’s employee could be attributed to Ehrlich because he directed and controlled the business and caused the statements to be made within the meaning of Section 6700.

Finally, the court upheld the IRS’s penalty calculation methodology. Section 6700 authorizes a penalty equal to 50 percent of the gross income derived from the prohibited activity. The court agreed with the government that the penalty should be based on Abbey Art’s overall gross income from the program rather than requiring proof of false statements for each individual transaction.

This decision highlights the risks faced by promoters of donation-based tax strategies and similar programs that depend on aggressive interpretations of ownership, valuation, or holding period rules. Courts will closely scrutinize whether customers truly acquire property interests sufficient to support charitable contribution deductions and whether promoters’ representations align with established tax law. The ruling also highlights the broad reach of Section 6700, including the IRS’s ability to impose penalties equal to half of the gross income generated by an abusive scheme and to attribute employee statements to the individual controlling the operation. 

As enforcement efforts continue to focus on abusive charitable deduction arrangements and tax shelter promotions, this case serves as a reminder that misstatements about tax benefits can lead to significant penalty exposure and litigation risk. If you have questions about this update, please contact Liskow attorneys Leon Rittenberg III, John Rouchell, Caroline Lafourcade, and Kevin Naccari and visit our Tax practice page.