By Rica Zeitoune.
Determining the value of art is typically an equivocal venture. The fair market value of a work of fine or decorative art is attributed to various factors other than a work’s aesthetic value, such as provenance, condition, and the length of time that the work was on the market. In addition to these contributing factors, appraisers may be influenced by further matters unrelated to the history of the work but concerned with its future.
Owners of art often seek accredited appraisals when considering estate and inheritance affairs or before donating their artworks for tax purposes. Both scenarios impose potential implications in determining value and may compel an appraiser in one of two directions. When a work is inherited, an owner would rather underestimate its value to ensure a smaller tax liability. The stakes of appropriately measuring the value of the work are severe, since the owner intends to assure that they are not bequeathing an illiquid asset with a heavy tax liability. If an owner decides to donate their work to a museum, they may prefer to enhance the value of their work in order to receive a larger tax deduction. The potential impact of these forces may compromise the fair market value of a work.
In order to keep more consistent valuations across the board, art appraisers conform with the Uniform Standards of Professional Appraisal Practice (USPAP) set by the Appraisal Foundation, which is based in Washington, D.C. Adherence to USPAP is required of art appraisal associations as well as examinations for recertification every five years. Accredited and generally accepted appraisal institutions are certified by three professional appraisal organizations: the Appraisers Association of America, the American Society of Appraisers, and the International Society of Appraisers.
The difficulties related to the elusive nature of art have also directly affected the functions of the Internal Revenue Service (IRS), more specifically, the Art Appraisal Service (AAS). The Art Advisory Panel of the Commissioner of Internal Revenue (“the Panel”) was established in 1968 to support the AAS by ensuring accurate claimed values for fine and decorative art. The Panel was first comprised of twelve members of prominent art market figures such as museum curators, directors, auction representatives, scholars, and dealers. Over the decades, the Panel has grown to approximately twenty members divided into two subgroups, the Fine Arts Panel and the Decorative Arts Panel. The Panel meetings, which are closed to the public in order to protect the personal information of taxpayers, occur twice a year.
The Panel is chartered under the Federal Advisory Committee Act (FACA) and was approved for a two-year renewal in February 2018. FACA, a law passed in 1972, recognizes advisory committees to government officers and agencies and sets regulations to govern the manner in which they operate. The legal framework of FACA encourages the objectivity of advisory committees. The AAS’s code is also outlined in the Internal Revenue Manual sections 18.104.22.168 – 22.214.171.124.
Any single work of art appraised above $50,000 for tax purposes is referred by an IRS agent to the AAS to review. The AAS can independently review the appraisal of the work provided or refer it to the Panel for an evaluation. The Panel is charged with reviewing appraisals of high-value work and suggesting an adjusted fair market value when necessary. The Panel requests documentation of a certified appraisal with explanatory notes in addition to several documents regarding the provenance and condition of the work. Once the panel arrives at an appraised value, they forward their recommendations to the AAS, which settles tax liability. The Panel’s recommendations only function as support or guidance to the AAS, therefore the AAS is not forced to abide by the panel’s decisions when finally deciding on a tax liability.
The Panel’s reports are released to the public two years after they are written.[i] The report briefly summarizes the Panel’s meeting and provides aggregate data representative of their appraisals. In 2017, 365 items with an aggregate taxpayer valuation of $205,433,138 were reviewed by the Panel. The Panel accepted 39% of appraised items and adjusted 61% (222 items). The average claimed value per item was $562,831.
The Panel’s recommendations are displayed in the annual report in gross numbers grouped by total number of increased items and the total number of decreased items. The report does not differentiate between revised values on charitable items and estate or gift items. Two works with differences between the taxpayer’s claim and the panel’s evaluation of over five million each were excluded. The high level data in 2017 is as follows:
- 128 items
- Taxpayer claimed value: $69,351,508
- Panel Recommendation: $120,679,749
- Net Change: $51,328,241
- 94 items
- Taxpayer claimed value: $56,019,030
- Panel Recommendation: $32,927,000
- Net Change: -$23,092,030
- 143 items
- Value: $80,062,300
Overall, the net adjustment was enlarged by $28,236,211, a 13.7% increase. The report did not disclose the percentage of recommendations the AAS adopted. The report has also become less transparent in recent years. Prior to 2015, the report released total adjustments for charitable items and estate and gift claims separately. The last available report in 2014[ii] shows an adjustment for estate and gift item claims was a 23% increase while the charitable items under review witnessed a 55% reduction, more than half their value.
Striving for Objectivity
These massive adjustments suggested by the Panel beg the question of whether the Art Advisory Panel adheres to the level of objectivity that they strive to correct for in the market. After all, the beneficiary is the U.S. government, which receives much of its revenue from IRS collections, and thus the AAS might be incentivized to push the value of the work in a certain direction. Therefore, the AAS itself is subject to the very same biases and issues it is attempting to mitigate.
The IRS advocates its objectivity in both its mission statement and annual reports. First, it claims that the panel is impartial to the appraised value because members of the panel are unpaid. Since they are not paid, the members’ only occupation is in the art world and their compensation does not relate to the the size of the tax bill. However, appraisers are prohibited from charging based on a percentage of the value of the work they identify; instead, they must charge a flat rate. These standards intend for appraisers to work objectively and reduce any incentive to overvalue a work. Therefore, the fair market value that a taxpayer originally claims on the basis of a certified appraiser should also be unbiased. The IRS also claims in its annual report that the information provided to the panelists does not include taxpayer information, the type of tax claim, and that the works are reviewed in alphabetical order by artist. Furthermore, the IRS states in the event of a conflict of interest the panelist is excused from discussions. The IRS also highlights the rigorous program it adopted and the intensive discussions that take place before revealing statistics.
The taxpayer can disagree with the Panel and may appeal with appropriate reasoning and supporting documentation for their conflict. The appeal is reviewed during the next panel meeting. If the taxpayer does not agree with the resolution, he or she may take the case to tax court. The taxpayer also has the option of skipping the appeal system entirely and taking the case to tax court directly.
The IRS Office of Appeals was established to resolve tax controversies in the most efficient manner for the taxpayer. The taxpayer must send a written statement within 90 days to the IRS and the statement is forwarded to the Office of Appeals if the issue cannot be quickly resolved. The Office of Appeals will set up an informal conference to discuss the matter. If there is still a disagreement, the taxpayer can bring the case to the United States Tax Court.
The most famous dispute between the panel and taxpayer in recent years was a case concerning a work in the estate of Ileana Sonnabend.[iii] When prominent collector and gallerist Ileana Sonnabend (1914-2007) passed, her estate inherited over $600 million worth of art. One of the works was Robert Rauschenberg’s Canyon (1959), a “combine-painting” that includes the carcass of a bald eagle. According to the Bald and Golden Eagle Protection Act (BGEPA) and Migratory Bird Treaty Act (MBTA), the possession without permit, sale, purchase, or export of a bald eagle, dead or alive, is prohibited. Therefore, characterized as unsellable and completely illiquid, the work was valued by the estate at $0 dollars. The advisory panel vehemently disagreed and first produced an unsigned or unofficial valuation of the work at $15 million; the estate soon followed with an appeal request. The advisory panel responded by formally valuing the work at $65 million, levying a $29 million tax liability. The reasons for the dramatic leap in price were not made clear; however, the Panel did note that they used works of similar esteem in the market for valuation purposes. The estate was also charged an $11.7 million dollar penalty fee for misrepresenting the value of the work.
The high estimate apparently was based on the illegal market activities.[iv] The AAS had deemed works with an illegal activity trail tax-liable before. However, in those cases there was a reasonable demonstration of a legal market for the works in question. For example, the advisory panel reviewed the case of Robson v. Commissioner.[v] There, a work of art also featured an illegal animal trophy, however, the sale of the work was only illegal in some states. As for the Rauschenberg in the Sonnabend estate, the Panel found that the work was still marketable, despite the eagle, and the IRS was able to produce a market value consistent with historical prices in legal sales. In the case of Canyon, the sale of the work itself would have been prohibited domestically and abroad, erasing any trace of demand. Ultimately, the estate and the IRS reached a compromise whereby the IRS waived the penalty fee and tax liability and Canyon was donated to the Museum of Modern Art (MoMa) in November of 2012. The work was valued at zero dollars and the Sonnabend estate claimed no charitable tax deduction.
Another groundbreaking case, Estate of Elkins v. Commissioner of Internal Revenue, was more recently resolved in September 2014.[vi] James Elkin and his wife Margaret owned a collection of modern art and had created a trust for several works, which resulted in fractional ownership by multiple parties sharing in title to the tangible assets. When Margaret Elkins passed away, each of her heirs acquired a stake in three of the works. James Elkin claimed a discount on gift taxes since he only owned a percentage of the work. The IRS rejected this view by choosing to disregard fractional ownership in art. On appeal, the case was brought to the U.S. Court of Appeals for the Fifth Circuit where James Elkin received a $14 million tax refund, in recognition of fractional gift giving in the art world.
With the intimate nature of the art world on the one hand and the guidelines that all appraisers must follow on the other, many are left wondering how necessary and convincing are the Panel’s opinions compared to that of the original appraiser. Finally, the opacity of the Panel and its procedure is a recurrent point of criticism, especially considering prior examples of dramatic differences of opinion and the grand sums of money that are at stake for both the taxpayer and the government. However, the AAS operates with the intent to ensure objectivity in artwork valuations submitted to the IRS for a variety of tax claims. Internally, measures are taken to maintain the privacy of the taxpayer and the neutrality of the evaluating panelists. Panel member and New York art dealer Howard Rehs opined, “[i]t’s really a well-done methodology that they follow.”[vii]
[iii] Charlotte Melbinger, Case Note, The Sonnabend Estate and Fair Market Valuation of Canyon, 163 U. PA. L. REV. ONLINE 239 (2015), http://www.pennlawreview.com/online/163-U-Pa-L-Rev-Online-239.pdf.
[iv] Id. at 251.
[vii] The secretive panel of art experts that tells the IRS how much art is worth, Glenn Dixon, The Washington Post, December 7, 2017.
- Alan Breus, Valuing Art for Tax Purposes, Journal of Accountancy, (July 1, 2010). http://www.journalofaccountancy.com/issues/2010/jul/20092096.html
- Annual Summary Report for Fiscal Year 2014, The Art Advisory Panel of the Commissioner of Internal Revenue. Here.
- The Appraisal Foundation.
- Deborah M. Beers, Esq. The Art of Valuation: Fifth Circuit Reverses Tax Court and Accepts Estate’s Appraised Values of Artwork in the Absence of Credible Evidence from the Commissioner, Bloomberg BNA Tax and Accounting Center, November 4, 2014. http://www.bna.com/art-valuation-fifth-n17179910906/
- Federal Advisory Committee Act, General Services Administration. Here.
- Internal Revenue Manual, Section 126.96.36.199 – 188.8.131.52, Internal Revenue Service. Here.
- Peter J. Reilly, Is Art Advisory Panel Giving Taxpayers a Fair Shake? Forbes, February 6, 2013. Here.
- Ralph E. Lerner, Withers, Art and Taxation in the United States, in Fine Art and high Finance, edited by Clare McAndrew, Bloomberg Press 2010.
- Valuation Assistance for Cases Involving Works of Art, in Internal Revenue Manual, IRS. Here.
About the Author: Rica Zeitoune is a senior at Binghamton University. Rica is pursuing a B.A. in Art History and a B.S. in Financial Economics.