You Can't Take It With You

Charles and Thomas Danziger are the lead partners in the New York firm Danziger, Danziger & Muro, specializing in art law. Visit the Danzigers' Website.

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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’s dungeon. Since most of our U.S. clients don’t have castles—and don’t want their heirs locked up in dungeons by the authorities—we 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.

LETTING THE HEIRS PAY.
Surprisingly, this approach—also known as the “I’m dead and don’t care” strategy—is 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’s 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.

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.

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 “fair market value”), 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.

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’s 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.

Moreover, Nass advises collectors drawing up a will to “be sure that your executors don’t have conflicts of interest that may lead to decisions that aren’t in the best interests of your beneficiaries.” 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’s 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.

LIFE INSURANCE.
A 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’s premiums. If the trust is structured correctly, the insurance proceeds are not part of the collector’s taxable estate, and at his death the trust’s beneficiaries can use the money to pay the estate tax.