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But you don\u2019t want to leave it all to the tax man. Given today\u2019s high art values, estate planning is more essential than ever.<\/strong><\/p>\n After a few too many whiskeys, a wealthy English art collector recently confided to us the crux of his estate tax plan: Following his death, his children had standing instructions to lock up all the good paintings in their castle\u2019s dungeon. Since most of our U.S. clients don\u2019t have castles\u2014and don\u2019t want their heirs locked up in dungeons by the authorities\u2014we advise them to do some thoughtful estate planning to maximize tax benefits and ensure that their art collections end up in the right hands. Here are several approaches to estate tax planning used by collectors today.<\/p>\n LETTING THE HEIRS PAY. Since art is an illiquid asset, executors often end up selling off works to pay estate taxes. This is apparently what happened with the billion-dollar-plus estate of the dealer Ileana Sonnabend, who died in October 2007 and whose daughter and adopted son reportedly covered the taxes by privately selling $600 million worth of sculptures and paintings.<\/p>\n A further complication for executors is that estate taxes are due no later than nine months after death. An auction is the preferred method of sale for many executors (who tend to view them, rightly or wrongly, as generating \u201cfair market value\u201d), but because the houses conduct only periodic sales, executors are occasionally forced to engage in quick private sales at below-market prices to raise cash to pay taxes. Alternatively, they might cover the tax obligation by selling other assets or by borrowing from a fine-art lender such as Emigrant Bank Fine Art Finance (formerly Fine Art Capital) or Citi Art Advisory Service.<\/p>\n Sophisticated collectors sometimes appoint special advisers in their wills to handle their art holdings. These specialists, who may be private dealers or even art attorneys, presumably have the necessary expertise to negotiate with auction houses, dealers and museums, all in accordance with the collector\u2019s final wishes. However, trusts and estates attorney Herb Nass cautions that the executor of an estate is not bound by this type of appointment in a will and may freely disregard it.<\/p>\n Moreover, Nass advises collectors drawing up a will to \u201cbe sure that your executors don\u2019t have conflicts of interest that may lead to decisions that aren\u2019t in the best interests of your beneficiaries.\u201d This was precisely the kind of situation involved in a famous 1977 New York Supreme Court case, In re Rothko. Shortly after the artist Mark Rothko died, his executors sold 798 of his paintings to Marlborough Gallery and a subsidiary at a price believed to be below market value, even though one of the executors, Bernard J. Reis, was an owner of Marlborough, and another executor, the artist Theodoros Stamos, wanted to exhibit at the gallery. Rothko\u2019s children and the New York attorney general successfully sued to have the contracts canceled and the executors removed in light of their clear conflicts of interest.<\/p>\n LIFE INSURANCE. GIFTS DURING LIFETIME TO FAMILY. GIFTS DURING LIFETIME TO CHARITY. Special technical rules apply to donations of art to charities, including the important \u201crelated use rule\u201d: In order for a work to be deductible at its fair market value, as opposed to its original cost, the charity must use it in a way related to the organization\u2019s tax-exempt purpose.<\/p>\n When artists donate their own works to charitable organizations, their deductions are limited to the cost of the materials they used to fabricate the pieces. If passed, the proposed Artist-Museum Partnership Act may change this to permit artists to deduct the fair market value of such donations. But the bill has so far died seven times in Congressional committee, with opponents arguing that artists should not be allowed to \u201cpaint themselves a tax deduction.\u201d<\/p>\n Collectors should be realistic about the hurdles involved in trying to donate art to museums. Institutions will often decline such donations, not wanting to commit the funds needed to store, conserve and exhibit works that do not necessarily enhance their collections.<\/p>\n GIFTS DURING LIFETIME OF FRACTIONAL INTERESTS IN ART.<\/p>\n In the past, savvy collectors took advantage of an IRS provision permitting \u201cfractional giving\u201d of art to charity. A collector could give a stated portion\u2014say, 10 percent\u2014of a work each year and take a deduction for the corresponding percentage of its value at the time, even retaining possession of the piece for part of each year. Unfortunately for collectors and museums, a much-criticized law enacted last year created major disincentives for these fractional charitable gifts of art. A new patch to the law has to some degree corrected the problem, however, and there is hope that the proposed Promotion of Artistic Giving Act will do what its name suggests. One sign that fractional giving isn\u2019t totally dead: Last December, Janice and Henri Lazarof made a fractional and promised gift of 130 Modernist works to the Los Angeles County Museum of Art that are estimated to be worth $100 million.<\/p>\n PRIVATE OPERATING FOUNDATIONS. One example of the latter approach is the foundation established by the Los Angeles collector Eli Broad. He has decided to give his personal collection, which now comprises about 400 modern and contemporary works, to the Broad Art Foundation when he and his wife die. The decision was a blow to LACMA, which had received $56 million from the foundation for construction of the Broad Contemporary Art Museum on LACMA\u2019s grounds and was hoping to be the recipient of the billionaire\u2019s vast collection.<\/p>\n EUROPEAN APPROACH. Collectors contemplating the cheerful topic of death and taxes\u2014and mindful of the adage ars longa, vita brevis\u2014should plan ahead. With solid professional advice and careful consideration, they may find ways of sparing their heirs a king\u2019s ransom in estate taxes, even if their castles are only condos in Queens.<\/p>\n “You Can’t Take It With You” originally appeared in the August 2008 issue of Art+Auction.<\/em><\/p>\n
\nSurprisingly, this approach\u2014also known as the \u201cI\u2019m dead and don\u2019t care\u201d strategy\u2014is used, intentionally or not, by many sophisticated people. The IRS currently taxes estates at an effective rate of 45 percent, with no tax due on the first $2 million or on anything passing to a surviving spouse. The exemption will increase to $3.5 million in 2009, and in the unlikely event that Congress takes no action, the estate tax will expire in 2010 (Note to collectors: That\u2019s a terrific year in which to die). Unfortunately for those who live into 2011, the exempted amount is currently set to return to $1 million that year. In addition, many states, including New York, New Jersey and Connecticut, impose their own estate taxes at effective rates of up to almost 9 percent.<\/p>\n
\nA frequently used method of preserving an art collection after death is to fund the estate tax through a life insurance trust. The collector estimates the projected tax (not always easy, given the changing laws outlined above), establishes a trust that purchases a life insurance policy in that amount and funds the trust each year with a sum equal to the policy\u2019s premiums. If the trust is structured correctly, the insurance proceeds are not part of the collector\u2019s taxable estate, and at his death the trust\u2019s beneficiaries can use the money to pay the estate tax.<\/p>\n
\nA very gratifying way to reduce estate tax is to bestow art on offspring during one\u2019s lifetime. A significant drawback of such gifts is that, depending on their size, they may trigger a hefty gift tax\u2014payable by the donor, not the recipient. This tax is intended to ensure that people don\u2019t deprive the IRS of estate taxes by giving away all their property during their lifetimes, so it\u2019s not surprising that gift tax rates are essentially the same as those of the estate tax. Trusts and estates expert T. Randolph Harris notes that any appreciation in value between the date of the gift and the donor\u2019s death avoids estate and gift taxation (which is good), although the recipients of lifetime gifts must use the donor\u2019s cost basis for a piece when they sell it (which may be bad). By contrast, appreciated assets bequeathed through an estate receive a stepped-up tax basis equal to their value at the time of the donor\u2019s death.<\/p>\n
\nA more tax-friendly way to give away art during one\u2019s lifetime is through donations to charitable organizations, such as museums or qualified not-forprofits. Donors receive income tax deductions while they are living, and upon their death, no estate tax is due on the donated objects, since they are no longer part of the estate. Such a donation may reap the added benefit of keeping an art collection together when the donor\u2019s ownership ends.<\/p>\n
\nArt held in a private operating foundation is not subject to estate tax, but the foundation itself is subject to strict irs rules [see \u201cCreating an Art Legacy,\u201d August 2004]. For instance, the foundation must actively promote a charitable cause. It may be used to establish a privately funded museum accessible to the public, or for lending art to different public venues.<\/p>\n
\nBritain allows heirs to pay its estate tax in art that is \u201cpreeminent for aesthetic merit or historical value,\u201d and France routinely accepts artworks as payment for its succession taxes. For instance, death duties for Picasso, who left no will, were paid largely in the form of his works, which now make up the core of Paris\u2019 Mus\u00e9e Picasso. The U.S., by contrast, generally does not accept in-kind payment of estate tax. It has done so only in very rare instances\u2014each of which required special authorizing legislation\u2014involving rare coins, historic photographic plates and land.<\/p>\n