Art collectors and investors won a victory in September when the Court of Appeals for the Fifth Circuit reversed a Tax Court decision, increasing the discount for a decedent’s fractional art interests and ordering a $14 million estate tax refund.
“It was a fantastic result for the estate,” said Diana Wierbicki, a partner at Withers Bergman and a member of the firm’s wealth planning practice group.
While the decision in Estate of Elkins v. Commissioner has limited applicability as a precedent, it will still be helpful to taxpayers, she said.
James Elkins and his wife Margaret owned 64 modern art works in Texas, a community property state. After his wife died, Elkins disclaimed 27 percent interest in 61 of the works, allowing it to pass in equal shares to his children free of estate tax. He died owning 73 percent interest in those works plus 50 percent interest in three other works—a Picasso drawing, a Jackson Pollock painting and a Henry Moore sculpture.
At the time of Elkins’ death, Sotheby’s valued the 64 pieces at $35 million. Deloitte then determined that the art works should receive a discount of 44.75 percent, which is what the estate claimed on its tax form.
While the IRS normally gives estate tax discounts on assets under shared ownership, it typically has not provided discounts on artwork on the premise that there is no functional market for fractional interests in art.
The IRS, therefore, denied a discount for the Elkins’ art collection and assessed a $9 million tax deficiency.
The estate challenged this assessment in Tax Court, presenting expert testimony that each artwork should receive a discount anywhere from 52 percent to 80 percent. The IRS stuck to its position that the decedent’s interests should not receive any discount, offering expert testimony that no recognized market for the sale of fractional interests existed. It did not present any evidence about the value or the appropriate discount that should be applied to the estate tax.
The Tax Court rejected the IRS’s position that no discount should apply, but it also rejected the valuation discount determinations presented by the estate’s experts. Instead, the court determined that the fractional interests should receive only a nominal 10 percent valuation discount for estate tax purposes.
On appeal, the Fifth Circuit affirmed the Tax Court’s finding that fractional-ownership discounts apply to interests in art, but found that the Tax Court had made a reversible error in applying a 10 percent nominal discount “in the absence of any evidentiary basis whatsoever.”
The appeals court based its $14 million refund award to the estate on the experts’ determination that discounts of 52 percent to 80 percent should apply.
Wierbicki said the only problem with this positive outcome as a precedent was that the Fifth Circuit focused on the fact that the IRS had failed to meet its burden of proof. “It’s unlikely that in the future the IRS wouldn’t present a percentage argument” for an appropriate discount. Nevertheless, the decision was “such a favorable result that even though it may be hard to use it as a precedent, to have those types of percentage discounts out there will help,” she said.
Wierbicki noted that in the 2007 Stone v. U.S. case in which the Ninth Circuit allowed a 5 percent discount, the taxpayer had argued for 44 percent discount. “It’s very likely that when the Elkins tax return was being prepared, they looked to the discounts that were asked for in Stone,” and asked for 44.75 percent.
Going forward, she said, when people ask for discounts on their estate tax return, companies that are making discount assessments will have the 5 percent from Stone to look at as well as the 52 to 80 percent range in the Elkins case.
