In a major victory for art collectors, the Fifth Circuit court recently gave a $14.4 million estate tax refund and affirmed the use of fractional interest discounts for artworks to reduce estate taxes. Rejecting the government’s random assessment of a 10% discount on the valuation of the art, the Fifth Circuit instead agreed that the estate’s assessment of 47.5% should be used. This ruling opens the door for art collectors to greatly reduce the taxable amount of their estates.
Art Collecting and Estate Plans
Prior to this ruling, there have been major issues for art collectors and estate planning. If wealthy families sell their art while they are alive, a 28% capital gains tax is added to any appreciation in the value of the art. If they keep the artwork in the estate after they die, the full value of the art is included in the estate at the full fair market value on the date of death.
The ruling in the Fifth Circuit that allows art owners to discount the value of their works is huge. Most art collectors do not want to part with their art, but most estate planning attorneys encourage it because it drastically reduces the overall value of their estate. Many art collectors are forced to sell, donate, or gift art to their children in their final years.
Elkins Artwork Case
In the case of Estate of James A. Elkins, Jr. v. Commissioner of Internal Revenue, the Elkins family began planning to transfer their artwork to the next generation. Mr. Elkins and his wife collected 64 different pieces of contemporary art over the last four decades that includes pieces from Picasso, Pollack, Cezanne, Twombly, Motherwell, Francis, and Hockney among others. The stipulated fair market value of these works is $24.6 million.
The couple used a variety of estate planning tools to begin transferring the artwork to their three adult children, including a GRIT, a co-tenancy agreement, a lease, and a disclaimer. When Mr. Elkins passed away, his wife predeceasing him, he held a 50% interest in three works and a 73% interest in the remaining 61 pieces.
The IRS claimed a deficiency notice on the estate, stating that it was impossible to own a fraction of a piece of art. The Elkins family disagreed, and they went to trial. The Tax Court dismissed all arguments made by the Elkins family and arbitrarily assigned a 10% discount to the art.
The family appealed, and the case went to the Fifth Circuit. This court overruled the Tax Court and agreed with the valuation of the fractionally owned artwork for the Elkins family. The Fifth Circuit stated that “…in the absence of any evidentiary basis whatsoever, there is no viable factual or legal support for the court’s own nominal 10% discount,” and “the Estate, as taxpayer, presented all of the evidence and a surfeit at that, further eschewing the propriety of a nominal discount.”
Effects on Estate Planning
The fractional valuation is based on what an art expert would say is a fair price for the artwork, discounted to the fractional value of ownership. To see the idea in action, the Elkins’ Jackson Pollack painting was valued at $6 million. Mr. Elkins had given away a 50% interest in the painting, dropping his estate tax value to $3 million. Taking into consideration the additional 47.5% fractional ownership discount the value added to his estate from that painting is only $1.59 million. This has the potential to greatly reduce the value of art collectors’ estates and any taxes due.