Art and the estate tax (updated, again)

The New York Times reports on the Elkins case, involving a victory for a wealthy family in a legal fight with the IRS on estate tax owing on a valuable art collection. This is the quote that caught my attention:

“My genuine view is this is a great result for taxpayers, but I don’t think everything is clear,” said Diana Wierbicki, a partner and head of the global art practice at Withers Bergman, a law firm. “The I.R.S. dropped the ball. The I.R.S. pushed this idea that you should get zero.”

The latter part of the quote concerns the discount that is applied, for tax purposes, to assets that might be difficult to sell outside of the family, such as a business or real estate. The IRS was treating art as a relatively liquid asset, but in the end a significant discount was allowed.

But consider the first part of the quote: “a great result for taxpayers”. Well, no. This is a great result for taxpayers with estates so large that they are subject to estate tax, which means an estate worth over $5 million (and note estate taxes only apply to amounts of wealth above that floor, there is still a very significant exemption). That’s a pretty small group of taxpayers. For all the other taxpayers, the other 99%, the result means that wealthy families can pay less in estate tax. Forbes gives more details of the financial arrangements of the estate (and can’t resist referring to the estate tax as the “death tax”, a phrase relied upon by those who think the rich currently pay too much tax in the US). Artnet opened its reporting of the story in a more straightforward way: “In what is being viewed as a victory for art collectors looking to dodge or minimize estate taxes …”

There are two issues here. One is the substance of the ruling: when valuing an estate, what is a fair and equitable way to do so? Is art a fairly transferable asset, or is it something like a family farm, difficult to transfer, or with high nonmarket value to keeping it “in the family”? A “great result for taxpayers” is one that contributes to a more efficient and equitable system, not just one that happens to result in a victory for an estate against the IRS.

The second issue follows, and I raised it briefly in my previous post. Tax policies that happen to favor artists, collectors, or museums, are not necessarily good tax policies on that ground alone. They might be, but the goal is a system that is fair for all citizens, not just those from the art world. Lower taxes for one means either higher taxes, or fewer public services for another. Reporters and bloggers in the arts should not rush to hail decisions that lean on the side of those in the art world without asking whether the decision can stand on general grounds of equity and efficiency. If art was previously being treated inequitably in the tax code, and the inequity was rectified, great. But if the result is to give special privileges to collectors not available to others, it needs a close and critical look.

UPDATE: Donn Zaretsky at the Art Law Blog writes:

Art was previously being treated inequitably in the tax code, and the inequity was rectified.

In a nutshell, the issue is as follows.  Suppose I have a $10 million Picasso and I want to sell you a 40% ownership share.  What is that 40% share worth?  You might say $4 million (40% of the $10 million total value), but if you think about it, that isn’t right because then you’d be stuck co-owning the piece with me, so there would be all sorts of hassles and complications involved (who gets to hang it on their wall and for how long, shipping and insurance issues, etc.) and, most important of all, you might not be able to sell it when you want or need to (because I might not agree).  So while you would certainly pay something for that 40% interest, you wouldn’t pay $4 million.  You would demand a (“fractional interest”) discount.  There’s nothing controversial about that, it’s well-established with other sorts of assets (e.g., real estate).  But for some reason the IRS insisted on treating art differently.  That inequity has now been rectified.

I’m grateful for the clarification. But the economist in me has some questions. Let use the same example. With the sale of a 40% ownership share, total wealth has been diminished: the original owner now owns 60% of the painting, which is now worth less than $6 million, and the new partner owns 40% of the painting, which is now worth less than $4 million. So the sale is an odd one: efficiency would suggest sole ownership. So what motivates the sale?

In the Elkins case, if the Times has it right, there was no sale at all: there was a transfer of part of the value of the paintings from Elkins to Elkins’ heirs with the explicit goal of lowering estate taxes. The motive for what, on the surface, looks like inefficient joint ownership, was tax avoidance. The Times even refers to it as a ‘tactic‘. In the end, I can’t shake my skepticism over this.

MORE UPDATE: Donn Zaretsky replies:

He’s [Rushton] troubled by the tax avoidance motive behind the transaction, which is fair enough (though as Learned Hand said:  “Any one may so arrange his affairs that is taxes shall be as low as possible; … there is [no] patriotic duty to increase one’s taxes”).  But if that’s a problem, it’s a problem across the board for fractional discounts.  There was no reason for the IRS to single out fractional discounts for art for different treatment.

And we are agreed.