Our estate tax system is quite different from our income tax system. The income tax, as its name implies, focuses on how much money individuals, trusts, and business entities make. The estate tax system, in contrast, focuses on how much assets are worth. Most assets aren’t hard to value. Stocks, bonds, mutual funds, and similar assets are valued at their publicly-traded fair market value (FMV) as of the date of death (or the executor can choose an “alternate valuation date” nine months later). But some assets are a little harder. Real estate, for example, is also valued at its FMV — but who’s to say what a unique or expensive property is really “worth,” especially in today’s volatile market? Closely-held businesses can be even harder to appraise. And high-end collectibles, like the kind of art and antiques that usually sell at auction, can be hardest of all.
These issues make estate-tax enforcement a different challenge from income-tax enforcement. For fiscal year 2010, the IRS received 42,366 estate tax returns, and audited 4,288, or 10.1%. But just as income tax audits go up as your income rises, estate-tax audits go up as your assets go up. For that same year, the IRS received 3,013 estate tax returns reporting assets of $10 million or more — and audited 928 of them, or 30.8%!
Occasionally, the IRS finds assets that are especially tricky to value. For instance, how do you value an asset that would be illegal to sell? That was the challenge the IRS faced with the estate of art dealer Ileana Sonnabend. Sonnenbend died at age 92 after amassing one of the country’s most important collections of contemporary art, including works by Jeff Koons, Roy Lichtenstein, Andy Warhol, and Cy Twombly. Her heirs valued her estate at $875 million, and sold several works to pay taxes of $331 million to Uncle Sam and $140 million to New York state.
But Sonnabend’s collection also included a 1959 work called “Canyon” by Robert Rauschenberg, best-known for his “combine-paintings” incorporating nontraditional materials and objects. And there’s a problem with that piece — it includes a stuffed bald eagle. Bald eagles aren’t just a symbol of America, they’re an endangered species. Selling any part of an eagle, even a single feather, is, well, il-eagle — punishable by a fine of up to $100,000 and a year in prison. (Yes, they will make a federal case out of it.) In fact, back in 1981, the Department of Fish and Wildlife notified Sonnabend that ownership of the piece was restricted by federal law. Sonnabend got permission to retain the piece and lend it to museums, but understood that she could never sell it or export it for sale.
Sonnabend’s executors obviously took that constraint into consideration, and valued the piece for estate tax purposes at zero. The IRS, not surprisingly, disagreed. They valued “Canyon” at $65 million — assessed $29 million in tax — and threw in an $11.7 “gross valuation misstatement” penalty for good measure! (The technical term for that is “holy smokes”!) The executors have filed suit, of course, but the IRS has a history of valuing illicit assets, like native American artifacts and stolen art and antiquities, at their “black market” value.
Smart planning could have avoided this whole mess. Sonnabend could have donated “Canyon” to a U.S. museum before her death. That would have avoided the absurd result of owing tax on an asset, but facing jail time for selling it to pay the tax! The good news in all this is that, at least from now through the end of the year, there’s no tax due unless your taxable estate tops $10 million. The bad news is that if you do leave enough to owe tax, you can almost count on being audited. So if your house is stuffed with contraband, the time to get rid of it is now! Other tax planning questions? Email us!
Donna Bordeaux, CPA with Calculated Moves
Creativity and CPAs don’t generally go together. Most people think of CPAs as nerdy accountants who can’t talk with people. Well, it’s time to break that stereotype. Lively, friendly, and knowledgeable can be a part of your relationship with your CPA as demonstrated by Donna and Chad Bordeaux. They have over 50 years of combined experience as entrepreneurial CPAs. They’ve owned businesses and helped business owners exceed their wildest dreams. They have been able to help businesses earn many times more profit than the average business in the same industry and are passionate about helping industries that help families build great memories.