Family Fortunes and the I.R.S.

Why do we tax what we tax?

In subsection C of §21. Other Property Exemptions of ARTICLE VII. REVENUE AND FINANCE of the constitution of the great state of Louisiana, the following is exempted from the property tax: "(19) All artwork including sculptures, glass works, paintings, drawings, signed and numbered posters, photographs, mixed media, collages, or any other item which would be considered as the material result of a creative endeavor which is listed as a consignment article by an art dealer."

Is Louisiana great or what --- an actual limitation on the power of government to tax. Louisianans themselves created this limitation in 2006 by voting for Amendment 5: the Exempt Art from Ad valorem Property Tax Act, which was legislatively-referred. What's interesting here is that we might surmise that prior to 2007 Louisianans were paying property taxes on their art, but not on categories of property that pose a cost to society. After all, your refrigerator can leak coolant, which some say destroys the ozone layer. But your Renoir just hangs there on the wall minding its own business.

Although Louisiana's voters had the good sense to exempt their art from state property taxes, it's still subject to estate taxes. The headline of an article by Patricia Cohen in the New York Times reads: "Art's Sale Value? Zero. The Tax Bill? $29 Million." Cohen reports on the fascinating, but perplexing, case of the IRS tax bill presented to the heirs of Ileana Sonnabend, a New York art dealer. The heirs inherited "Canyon," a painting by Robert Rauschenberg that cannot legally be sold because it contains the carcass of a bald eagle, a protected species:

While art lovers may appreciate the I.R.S.'s aesthetic sensibilities, some estate planners, tax lawyers and collectors are alarmed at the agency's position, arguing that the case could upend the standard practice of valuing assets according to their sale in a normal market. I.R.S. guidelines say that in figuring an item's fair market value, taxpayers should "include any restrictions, understandings, or covenants limiting the use or disposition of the property."

My theory is that the "aesthetic sensibilities" at the IRS told them that they better tax while the taxing is good, because the "normal market" for Rauschenbergs may have already peaked. In "The Illegal Eagle and a Baldly Grasping IRS" last December in the Wall Street Journal, Eric Gibson reported on the resolution of the Sonnabend heirs' "five-year absurdist farce" with the taxman:

Ms. Sundell and Mr. Homem [the heirs] had another option: donate "Canyon" to a museum. But since they were declaring that it had no value, they would have to forfeit the charitable deductions that normally accrue to individuals in such cases. In the end, this is what they chose to do. "Canyon," which had been on extended loan to the Metropolitan Museum of Art, now joins five other Rauschenberg combines at MoMA. In exchange, the government has dropped its $40 million-plus claim against Sonnabend's estate.

In case you noticed that the government's claim had risen, that's because when the heirs rejected the government's initial appraisal of "Canyon," the IRS raised its appraisal by $50M and then slapped on an "undervaluation penalty" of $11M. The IRS claims that the heirs had made a "gross understatement" of the painting's value.

Sonnabend's heirs had to sell $600M worth of the $1 billion collection just to pay the $471M they owed in federal and state estate taxes. They were wise to have resolved their dispute before the tax hikes of the Fiscal Cliff kicked in on January 1. The estate tax rate is now 40 percent (up from 35) on amounts over $5M, indexed for inflation.

At Forbes, Janet Novack reports that the fed's share of the Sonnabend estate was $331M and New York State's was $140M. So if Ms. Sonnabend had stuck around another six years and not croaked until 2013, her family would have owed an additional $69M or so to the IRS. Which would have put their total tax rate on the estate at above the 50 percent sensible Americans think should be the upper limit of government's take.

Missing from the news stories I've read on the Sonnabend affair are the sales taxes paid on that $600M worth of art that was sold to pay estate taxes. In 2011, the total sales tax rate in New York City was 8.875 percent. Some art dealers, however, avoid paying New York sales taxes. Also missing from the total cost of settling the estate are the fees for lawyers, accountants, and art appraisers, as well as any court costs, incidentals, etc. There's quite a living to be made off the dying.

One reason that government taxes art collections is because they're easy pickings. The art world, you see, is rather punctilious about provenance: the recorded history of ownership of artworks. So the government already knew of Ms. Sonnabend's collection.

Another reason the feds tax art is because it's mainly owned by rich folks. Sadly, many Americans see nothing wrong with the IRS skinning the wealthy while they themselves don't pay a cent. After all, the rich "don't need it." But the lumpenprole should be concerned about the government preying on the rich; if it can happen to the rich, it can happen to them. If the feds can tax Sonnabend's Rauschenberg, they can also tax the image of your mother that your grandfather painted. The IRS says your painting is worth $1M, and neither you nor your mother paid estate taxes on it... time to pony up.

One wonders how sickened Ileana Sonnabend would have been to see her beloved art collection broken up and sold. If she had retained another estate planner, perhaps she could have kept it intact. ARTnews reports that Ralph Lerner, the lawyer representing the Sonnabend estate, said: "The IRS is saying you have to pay the tax. If you sell the work to raise the money to pay the tax, it's a criminal offense and you go to jail."

Since "Canyon" had a fair-market value of zero, the IRS should have let the family keep the painting tax-free. But perhaps the IRS was calculating that the family would grow weary of fighting the agency, give up, and donate their painting to the government, perhaps the National Gallery(Or maybe the IRS was just drunk on power).

Think about it: A painting that goes through two estates can now have 80 percent of its value taken by the IRS just for federal estate taxes alone. Throw in state estate taxes and sales taxes if the painting is sold (perhaps to pay estate taxes) and an amount greater than the value of the painting can easily be grabbed by government in short order. That's not only confiscatory, it's predatory. How does government justify the taxing of art that is loaned to museums for the public to enjoy?

Not only are family businesses and family farms being broken apart and sold just to pay estate taxes, so are family art collections. Family fortunes are being split apart so that progressives can keep funding their welfare state. Unfortunately, advocates of Big Government have never properly understood family.

Jon N. Hall is a programmer/analyst from Kansas City.

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