Fractional Interest & FMV for Living Artists

The Weekly Standard has an interesting article on fractional interests and artist deductions. While most is background information many appraisers are already aware of, there is some interesting and useful content.

The Weekly Standard reports

"This is the death of fractional gifts," Manhattan art assets advisor Ralph E. Lerner told the New York Times in 2006, just a few weeks after Congress enacted the Pension Protection Act, which (among other provisions) placed certain limits on the length of time that collectors may take deductions for their gifts of high-value artworks to museums, as well as not permitting these donors to increase the deduction they take over time based on the artworks' escalating value.

Fractional gifts didn't die and continue to be a normal way that donors may receive the full tax benefit of valuable objects (charitable gifts are deductible only up to the limit of 30 percent of the donor's annual income), but don't judge Lerner too harshly. Lots of museum directors, the advocacy groups for museums and museum directors, the lawyers for wealthy collectors, and plenty of others all screamed bloody murder back in 2006. "[T]he necessity to complete the gift in a ten-year period is a serious impediment to donors making substantial gifts," Gail Andrews, director of the Birmingham Museum of Art and one-time president of the Association of Art Museum Directors, wrote to John Lewis, then chairman of the House Ways and Means Oversight Subcommittee in 2007. Do something! New York senator Charles Schumer and then New Mexico representative Tom Udall heard the call and introduced bills in Congress to right this great wrong. ("In trying to close a tax loophole, the Pension Protection Act suffocated a time-honored method of giving that has made many of our national treasures available to the public," Udall announced.)

The legislation went nowhere, and the screaming died out. Although in 2006 and 2007 the directors of museums hinted darkly at collectors of important artworks who were refusing to donate these pieces until the law was changed, these institutions continue to receive major gifts and at the same rate as before. No one now talks about the great impediment of a 10-year limit on tax deductions. "People are still making gifts," Gail Andrews later acknowledged, for a reason most succinctly expressed by Gary Vikan, director of the Walters Art Museum: "Philanthropy is not a tax proposition."

Certainly, not a tax deduction proposition. For some collectors, estate taxes may be a more relevant concern. Eventually, the owners of valuable pieces will have to do something with them: If they sell the art, they pay capital gains of 28 percent; if their heirs receive it, the estate will pay inheritance taxes, up to 40 percent. Donations are the principal way in which wealthy people and estate executors look to lower the amount on which a tax would need to be paid. (They also get feted for their gifts, rather than just receiving a tax bill from the government.) As long as there are inheritance taxes and the threshold for tax-free inheritances is less than some very high-priced artworks, it is likely that donations to one museum or another will remain the order of the day.

So, what was all the screaming about? And, when we hear more screaming by the nonprofit community—for instance, about efforts by the Obama Administration to lower the tax deduction for charitable gifts from 35 to 28 percent for the wealthiest taxpayers, which would "kill" nonprofits— how seriously should those dire predictions be taken? Similar worries were expressed in the early 1980s when the marginal tax rates were reduced, making deductions less valuable for high-end earners. This tax cut did not lead the rich, or those who weren't rich, to stop donating to charity and, instead, the amount of donations of money and objects grew throughout the '80s. It became clear that people make donations when they feel prosperous and less inclined to do so during a recession, not because of a change in the tax law. The case gets made that tax incentives drive charitable giving and that helping the super-rich is really benefiting museums, culture, education, our national heritage, we the people. (It is so easy it is to line up behind the fattest cats in the country.) All the while, the museum directors, the advocacy organizations, the arts lawyers and others knew all along that the case they were making on behalf of undoing the 2006 limitations on fractional gifts was contradicted by fact and experience. ("Yeah, year, I know," Lerner said when reminded of Leonard Lauder's gift of 78 cubist paintings in 2012 to the Metropolitan Museum of Art, worth a reported $1 billion.) The Wadsworth Atheneum's former director and chief executive officer, Susan Talbott, claimed that, "so much of our acquisitions are dependent on long-term relationships that have been cultivated by us with our donors. These donors have a relationship with the museum or with the collection, and the subject of the tax code doesn't come up." The facts contradict the much publicized fears of those hand-wringing museum directors, and the 2006 law also represents good public policy: The rich shouldn't be permitted prolonged and ever-increasing deductions as an incentive to make charitable donations. However, too many museum directors long ago decided that their main constituency is the wealthy, and on the subject of fractional gifts too many of them took up the banner of promoting that small group's interests, rather than the interests of the larger society.

Many, if not most, art museum directors also have supported another change in the tax, one that would aid living artists. The Tax Reform Act of 1969 took away the right of artists, composers and writers to deduct the fair market value of the works that they donate to charitable institutions, such as museums, allowing them only to deduct the cost of materials used in making the pieces. (Since most artists annually deduct the cost of their materials as part of ordinary record-keeping, they usually can claim no deduction at all for their gifts to museums.) The law initially did appear to affect museums adversely. Between 1967 and 1969, New York's Museum of Modern Art received 321 works of art (drawings, paintings, prints and sculpture) as gifts from the 97 artists who had created them. During the next three-year period, 1970-72, only 15 artists donated 28 works, most of which were prints. As a result, in every Congress since 1970, there has been a bill to allow artists once again to take a full fair market value deduction on their tax returns for their gifts. Vermont senator Patrick Leahy's "Artist-Museum Partnership Act" is the current initiative in this area. Museum directors have complained that the disincentive has made artists unwilling to donate their work, which has deprived the public of access to contemporary art.

Restoring the fair market deduction for artists potentially would result in "the possibility of gifts from dozens of artists who today are unable to part with their works without a substantial opportunity cost," said Maxwell Anderson, former director of the Dallas Museum of Art and one of the leading advocates for this change in the tax law.

Legitimate arguments may be made for and against restoring the fair market deduction for artists. Why shouldn't they receive the same tax incentives as the buyers of their work? Wouldn't an incentive to give provide more artwork for the public to see? On the other hand, it can be argued that deducting actual costs rather than the presumed value might seem the appropriate tax treatment, because one should not be able to deduct income that has not been earned. (When collectors donate what they actually paid for, the gift does represent a sacrifice.) As a practical matter, if artists want to have the same tax deductions as non-artist donors to museums, they simply can sell their work and contribute the earnings to these public institutions.


Also, as a practical matter, artists do donate their work to museums and other charitable organizations—perhaps at a lower rate than before 1969, although there is no documentation of how many artists gave how much of their own work during this period or since then—even at the price of not receiving tax deductions. Getting their artwork into public collections is of great interest to artists, as it improves the artists' professional standing and prices on the primary and secondary markets, and a growing number of them direct their dealers to require buyers to sign contracts that obligate them to donate what they purchased to a museum rather than to put it back on the market. Artists benefit in the long-run even if they do not in the short-term.

A larger question is raised, however: Are visitors to American museums actually deprived of seeing the work of contemporary artists as a result of this law? The answer has to be no. Back in 1969, there were far fewer contemporary art museums, and relatively few museums in this country were eager to acquire contemporary art. These days, one museum after another, small and large, trumpets its acquisition of contemporary artwork, and the amount of this art being purchased by or donated to museums is on the increase. Certainly, the individual artists aren't always benefiting from these gifts, but the public is, and tax policy is written to benefit society at large rather than just a small group of individuals. It is not good public policy to provide artists with a tax break for actions that are being accomplished without the break.

Perhaps, there might be more donations of contemporary art were individual artists offered the tax incentive, but it is difficult to assess how much more and if museums would be getting the objects they want. In Senator Leahy's legislation, donated artwork must have been created at least 18 months before the gift is made, in order to prevent artists from painting themselves a tax deduction when they estimate their tax payments. In addition, the artwork must be formally appraised, and the institution receiving the gift must assure the IRS that it actually wants the piece (those two provisions would weed out a lot of clear-out-the-closets type of artwork). Too, the value of the deduction cannot exceed the artistic gross income of the artist, and the deduction cannot be carried over from one year to another. One could assume that the principal beneficiaries of a change in the law would be a relatively small number of successful, already wealthy artists.

Source: The Weekly Standard