In Elkins vs. Commissioner the difference between an 11 percent and a 44.75 percent discount for gifts and the amounts in question were large enough to mandate careful examination. It defined the tax on 64 works of fine art with $35,180,650 in stipulated fair market value. A sizeable tax refund plus interest was decided for the tax payer.
Art lawyers, fine art appraisers, business appraisers, estate planners as well as art collectors and museums have a meaningful stake in this precedent or precedents being made. Reactions among professionals abound about the significance of Elkins which in which the 5th Circuit Court reversed the tax court’s 11 percent discount and held for the tax payer with a 44.75 percent discount. Many practitioners feel that the case does not offer a reliable basis for discounts going forward because the IRS did not offer any guidance on a particular discount. As such, the Judges on appeal said they had no choice but to rely on the 44.75 percent maintained by the tax payer.
As such, many art law experts are opting to ‘wait until a more definitive opinion is held’ and put little weight on what Elkins had to say. However, re-reading the tax court and appeal yields considerable bases for interim planning from a pro–con perspective.
The ‘wait and see’ strategy is a safe one for clients who are assured of not dying in the interim period. The question lies in what Elkins offers to estate planners and appraisers while awaiting the next case. For those with guaranteed life expectancy beyond 2014 – you need not read further in this comment.
The tax court opinion declined to hold for the commissioner’s zero discount. – Notably the appeals court agreed: “The Commissioner appears to have ignored, or been unaware of, the venerable lesson of Judge Learned Hand’s opinion in Cohan: In essence, make as close an approximation as you can, but never use a zero. See Cohan v. Comm’r, 39 F.2d 540, 543–44 (2d Cir. 1930).”
From an economic point of view the Elkins reversal offers many aspects of valuation of partial ownership of art with likely application to non-art ownership interests.
The tax court analysis focuses on IRC section 2703(a)(2), an important consideration in valuations of all partial interests, such as partnerships, minority ownership and fine art among other assets. This is often referred to as the ‘business purpose’ character in valuation.
IRC section 2703 states that discounts from pro rata can be considered if “subsection (a) shall not apply to any option, agreement, right, or restriction which meets each of the following requirements:
“(1) It is a bona fide business arrangement.
(2) It is not a device to transfer such property to members of the decedent's family for less than full and adequate consideration in money or money’s worth.”
The tax court’s analysis considered many cases where minority and non-control discounts were at issue. The tax court’s treatment of valuation factors in the Bright, McCord, Stone cases and many others. The mixture of fact and law in these and other decisions reflect discounts for minority and non-control. The discount debate has a long history and is far from a precise definition in court or marketplace.
The tax court carefully considered the psychology issues in the Elkins family and their aversion to any sale of their individual partial ownership interests. The appeals decision seems to favor reliance on economic issues that question individual ownership, the incentives at the valuation date and contingencies over time.
Most of these issues are far from a solid basis in law or economics. One notable difference was the tax court’s acceptance of an expert’s position that the lack of any reliable transaction bank for partial art transfers would support a lack of any discount proffered by the commissioner. The appeals court put forth the opposite view that lack of partial art transactions could support a basis for discounts from pro rata.
Elkins offers an opportunity to prepare that will require coordination of art law, fine art appraisal and business valuation. Ongoing litigation should clarify discounts for lack of marketability and non-control. This case suggests that the time has arrived to widen the discussion or pay a penalty for ‘watchful waiting’. Taken together, decisions to wait are at the planner/owner/appraiser’s peril.
Walter L. Zweifler, ASA, CVA, is CEO at Zweifler Financial, which values businesses, professional practices and a broad array of intangible assets. Zweifler has been active in the appraisal profession since 1976. He can be reached at his email address [email protected]
