Vagaries of Valuation for Collections of Artwork

By Elizabeth Summers*

Screen Shot 2017-10-12 at 4.57.56 PMFor better or for worse, the world cares how much collectors pay for art. A record price realized at auction or in a “private” sale can create headlines in both art world publications and the national press. The final value of a collection, however, is determined only upon the collector’s death, when the personal representative of the estate assigns a value to the art for purposes of the federal estate tax. Issues surrounding the valuation of art have generated extensive and energetic litigation in the U.S. Tax Court and, by extension, considerable interest among estate planning attorneys.

General Rules of Estate Tax Valuation

The value of a decedent’s gross estate is determined by calculating the value of all property the decedent owned at the time of his or her death, wherever such property is situated. (IRC Section 2031) Under IRS regulations regarding valuation for estate tax purposes, the value of every item of property includible in a decedent’s gross estate is its fair market value at the time of the decedent’s death. (T.R. Section 20.2031-1(b)) The IRS defines “fair market value” as the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of the relevant facts. With unique objects like individual works of art, the determination of a “fair market value” may be difficult. Fortunately, the IRS has provided additional guidance. Special rules apply to tangible personal property “having marked artistic or intrinsic value” of a value in excess of $3,000. Items that fall into this category must be formally appraised, and the appraiser must be competent in the specific subject matter of the appraisal. The appraisal of a painting of “artistic value” must include a description of the size and subject of the painting and the name of the artist. The appraisal must be filed with the estate tax return, along with a written statement by the executor containing a declaration that, under penalty of perjury, the appraisal is complete and accurate, and the appraiser both qualified and disinterested.

Valuation of Works of Art

While relatively minimal guidance exists in the Internal Revenue Code and Treasury Regulations specific to the valuation of art, subsequent IRS publications have created further special requirements for works of art that have been appraised at $50,000 or more and are transferred at death. The IRS now provides a procedure through which the executor of an estate may request a “Statement of Value.” The Statement of Value is effectively a pre-approved appraised value, issued by the IRS, that the executor may rely on to substantiate the value of a work of art for purposes of the estate tax. 

For the purpose of the Statement of Value requirements, the IRS defines “art” as “paintings, sculpture, watercolors, prints, drawings, ceramics, antique furniture, decorative arts, textiles, carpets, silver, rare manuscripts, historical memorabilia, and other similar objects.” The executor must request a Statement of Value for an item prior to filing the federal estate tax return that first reports the transfer of the art work. The request must include the following: a copy of the appraisal; a description of the work; the appraised fair market value; the cost, date and manner of acquisition; the date of death; and the location of the IRS District Office with jurisdiction over the estate tax return. The current fee for a Statement of Value is $5,700 for one to three items, and $290 for each additional item.

An appraisal submitted for purposes of securing a Statement of Value must contain, among other information, a detailed description of the work, a professional photograph, the specific basis for the valuation, and a statement that the appraisal was prepared for estate tax purposes. The appraiser must prepare, sign and date the appraisal and sign a statement attesting to his or her competency and expertise. The appraisal must be prepared within 60 days of the valuation date, and the executor must sign the request for the Statement of Value under penalty of perjury. While the Statement of Value procedure constitutes a kind of insurance against challenge for the valuation of an asset that might otherwise be subject to significant scrutiny, it can be time-consuming and expensive.

All returns selected for evaluation or requests for a Statement of Value that include an artwork with a claimed value in excess of $50,000 will be submitted to the IRS’s Art Appraisal Services department for possible review by the Commissioner’s Art Advisory Panel. The IRS established the Art Advisory Panel in 1968 for the purpose of assisting the IRS in evaluating appraisals of art. The Panel is composed of renowned curators, dealers and art historians from across the United States. In 2015, the most recent year for which a report is available, the Art Advisory Panel reviewed 446 appraisals of artworks, representing a total value of almost $650 million. Of these appraisals, the Panel recommended adjustments to the appraised value of the property approximately 65% of the time. While the IRS is not technically bound by the Panel’s recommendation, in practice, its opinion is generally decisive.

Because the outcome of an appraisal can dramatically affect the amount of estate tax the collector’s estate owes, it should come as no surprise that art appraisal issues have been extensively litigated in the Tax Court over the past decade. Following are some recent cases of interest.

Effect of Economic Forces in the Estate of Bernice Newberger v. Comm’r, T.C. Memo. 2015-246 (2015).

In some cases, the appraised value of a work may not be the best indicator of value and in such instances the Tax Court may also consider relevant sales and the effects of larger economic forces upon the art market. The variations in market and appraised value are well illustrated by the ruling by the Tax Court reached in regards to the Estate of Bernice Newberger . Upon Bernice Newberger’s death in July of 2009, her art collection included Pablo Picasso’s Tete de Femme (Jacqueline), an untitled work by Robert Motherwell, and Jean Dubuffet’s Element Bleu XV. In early 2010, Christie’s appraised the Picasso at $5 million. Sotheby’s appraised the Motherwell at $450,000 and the Dubuffet at $500,000. The Picasso sold in an auction at Christie’s on February 2, 2010, for over $12 million. The estate listed the appraised values on the estate tax return that it filed in October of 2010. The return made no reference to the 2010 February sales price of the Picasso. The estate continued to hold the Motherwell and Dubuffet.

The IRS issued a notice of deficiency stating that the Picasso, the Motherwell and the Dubuffet had values of $13 million, $1.5 million and $750,000, respectively. The IRS based its adjusted valuation on the February 2010 sales price of the Picasso, the sale of a comparable work by Motherwell for $1.4 million in November of 2010, and the sale of a comparable work by Dubuffet for $825,000 in November of 2007. The estate promptly appealed, asking the Tax Court to honor the original $5 million valuation because the Christie’s sale was “a fluke,” and arguing that the comparable sales prices for the Motherwell and the DuBuffet failed to take into account the effects of the global recession of 2008-2009.

In a remarkably nuanced decision, the Court held for the IRS in valuing the Picasso at $10 million, which the IRS expert had arrived at by adjusting the sales price to account for July 2009 market conditions. However, the Court held for the estate regarding the Motherwell and Dubuffet works, finding that the estate’s experts had properly taken into account the depressing effects of the global recession on the art market at the time of Ms. Newberger’s death. The Court made specific reference to the IRS expert’s “inexplicable” valuation of the estate’s Motherwell at a price above the sales price for the comparable work, which was sold in November of 2010, after the art market recovered.

Fractional Interests in the Estate of Elkins v. Comm’r, 767 F.3d 445 (5th Cir. 2014)

The ownership of a work of art can be divided into a number of fractional interests. While fractional interests allow the owner to discount the value of his or her property for lack of marketability and control, they can create significant hurdles for the appraiser.   

James Elkins built an impressive art collection over his lifetime, including works by Pablo Picasso, Jackson Pollock, Jasper Johns, Cy Twombly, and David Hockney. By the time of his death, James Elkins owned fractional interests in 64 pieces of artwork. Specifically, Elkins owned a 73.055% interest in 61 of the works, subject to a restrictive co-tenant’s agreement with his children (the holders of the remaining fractional interests), and a 50% interest in a grantor-retained income trust (“GRIT”) that owned 3 works. Following Elkins’ death in February of 2006, his executor valued his 73.055% interest in the 61 works owned in conjunction with his children at approximately $9.5 million, and his 50% interest in the GRIT at approximately $2.6 million. To reach this value, the executor commissioned an appraisal from Sotheby’s, determined Elkins’ pro-rata share of the value of the appraised works, and applied a 44% discount to the pro-rated appraised value for lack of marketability and control. The IRS issued a notice of deficiency valuing the estate’s 73.055% interest at approximately $18.4 million and the 50% interest in the GRIT at $5.3 million. See Estate of Elkins v. Comm’r, 140 T.C. 86 (2013). 

The Tax Court disregarded the restrictions in the co-tenancy agreement between Elkins and his children and, with it, the estate’s 40% discount. The discount was reduced to 10% to account for the uncertainties a hypothetical buyer would face in determining a resale value in light of Elkins’ children’s continuing interests in the works. Understandably, the estate appealed.

On appeal, the Fifth Circuit Court of Appeals reversed the Tax Court ruling and held that indeed the estate was entitled to a higher discount for the fractional ownership.

Conflicts of Interest in Estate of Kollsman v. Comm’r, T.C. Memo. 2017-40.

In evaluating an appraisal, the IRS will also scrutinize the motivations of the appraiser as it did in the review of the valuations submitted for the Estate of Kollsman. Upon her death, Eva Franzen Kollsman owned two old master paintings: Maypole by Pieter Brueghel the Younger, and Orpheus attributed to Jan Brueghel the Elder, Jan Brueghel the Younger, or a Brueghel studio. A Sotheby’s specialist sent a brief letter to the executor of Kollsman’s estate appraising Maypole at $500,000 and Orpheus at $100,000, which values the estate included on Kollsman’s federal estate tax return. The same specialist also sent another letter proposing that the estate grant Sotheby’s an exclusive right to auction both works, and stated an estimated value at auction of $600,000-800,000 for Maypole and $100,000-150,000 for Orpheus. The estate accepted Sotheby’s proposal. The IRS issued a notice of deficiency, finally asserting a value of $2.1 million for Maypole and $500,000 for Orpheus.

At trial, the Court essentially disregarded the Sotheby’s appraisal, believing the appraiser gave a low estimate in order to reduce the estate’s tax burden and “curry favor” with the executor for the purpose of securing the right to auction the works. The Court accepted the IRS’s valuations, applying only a 5% discount for the risks associated with cleaning the paintings and an additional 20% discount for Orpheus due to the work’s generally poor condition and the uncertainty of its attribution.

The manner of disposition of the collection may also be relevant for purposes of valuation. Some estates include a “blockage discount” in the calculation of the value of a collection. A blockage discount accounts for the difference in the overall value realized if a number of works by a single artist are liquidated at once, as opposed to being sold off one by one. Selling a large “block” of works risks flooding the market and devaluing all of the artist’s work. Blockage discounts have been utilized in a number of collectors’ and artists’ estates, including those of Georgia O’Keeffe and Andy Warhol.

The IRS contested the application of a blockage discount to the appraisal of certain works of art owned by the estate of Lisa de Kooning, the daughter and sole heir of the abstract expressionist Willem de Kooning. Upon de Kooning’s death in 2013, Christie’s valued her collection of her father’s paintings and sculptures at $231 million. The estate commissioned two experts to calculate the amount for a blockage discount for the collection. The experts determined that the appropriate discount would be 60% for the paintings and 85% for the sculptures, and consequently valued the entire collection at a total of approximately $100 million. The estate submitted a request for a Statement of Value reflecting this amount. 

After consulting the Art Advisory Panel, who advised that the value of de Kooning’s works would only increase over time, the IRS rejected the blockage discount and issued a Statement of Value of approximately $255 million. This figure included a 50% discount for sculptures valued at over $100,000. Undeterred, the estate challenged the Statement of Value in its return and submitted additional information regarding the blockage discount. The IRS promptly disallowed the sculpture discount and, without making any adjustment to the Statement of Value, increased its value of the collection by $60 million to approximately $315 million. In February of 2017, the estate filed a case with the Tax Court to contest the IRS’s new position and the resulting $92 million tax bill. As of the date of this article, the case remains pending and the result shall be of keen interest to both estate planners and art law enthusiasts.

Conclusion

Despite the guidance provided by the IRS and relevant case law, the appraisal of art for estate tax purposes remains more of an art than a science. The valuation of artwork is intensely fact-specific, subject to a short time horizon, and dependent on the state of the art market. For those in New York City on November 10, 2017, the upcoming Art Law Day organized by the Appraisers Association of America might be of some interest.

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*About the Author: Elizabeth A. Summers is a Trusts and Estates Associate with a firm in Minneapolis, Minnesota, where she specializes in wealth transfer planning for high net worth individuals and families. 

Disclaimer: This article is intended for educational purposes only and is not meant to provide legal advice. Any views or opinions made in the linked article belong to the author alone. Readers are not meant to act or rely upon the information in this article and should consult a licensed attorney regarding their specific situation.

Donating Art – Not as easy as you may think…

By Aaron M. Milrad, first published on the Dentons website on 2 April 2015.

Owner

In advising potential art donors I find my clients are surprised when I ask “Are you the owner of the art?” At times there is no quick or obvious answer. Who was the buyer of the art? Who was listed on the Bill of Sale? Is it you, your spouse or your corporation? What if you and your spouse are no longer married and living together, but the Bill of Sale shows that the artwork was sold to Mr. and Mrs. X? Who can donate it? Keeping the original Bill of Sale is an important aspect of donating art as a museum or art institution will ask you to sign a Deed of Gift confirming that you are the owner of the art and have authority to donate it.

The deed of gift

The Deed of Gift will also ask you to warrant that the artwork is free and clear of any encumbrances; that is, that you have not pledged it to the bank for a loan or an ongoing loan agreement and that no creditor has filed any claim against your assets, including the artwork.

It is also common for the Deed of Gift to ask, and have you confirm, that the artwork has not been imported into Canada in contravention of any cultural property laws of the country of origin of the artwork (a Mexican object, as an example) or in contravention of Canadian law.

Canada is a signatory to UNESCO Convention dealing with the rules for importing and exporting of cultural property from member states.

Where to donate?

Mandates of collecting differ significantly from one institution to another. Selecting the right institution is important as the donor does not wish to be embarrassed by having an institution refuse the work as being outside its mandate. For example, the George Gardiner Museum of Ceramic Art collects only ceramics and related material. Other museums may collect only Canadian art or military art – or may not collect at all and may only exhibit art on loan.

Institutions will consider other factors:

  1. How important is the artwork;
  2. How the work fits into its collection;
  3. The size of the work;
  4. Whether it can be easily accommodated in storage; and
  5. How often the institution will want to show the work to the public (that is, its importance as art).

Your personal appreciation of the work in question does not necessarily make it an important work for an institution to receive as a donation. There must be a value and a relationship to the institution’s existing collection to warrant its acceptance of the work. You should ask the institution in advance as to its mandate and what the institution may be looking for in the way of art donations.

Donation of money

It is not unusual for an institution to tie its acceptance of the art donation to a requirement that the donor also contribute money to help cover the cost of “the care and feeding of the artwork”, and/or the cost of independent appraisals by professional appraisers to establish the fair market value of the art donation that will be reflected on the donor’s tax receipt. Often times, such a monetary contribution can be made to the institution for its general purposes. Care has to be taken to avoid direct or directed payment to the appraisers, as this may not qualify as a donation for income tax purposes.

Fair market value

If a tax receipt is requested or required, the artwork must be valued by independent appraisers at or near the time of the donation. Sometimes the curator of the institution itself may appraise the work. If the artwork has an original cost and a current value less than $1,000, there is no tax ramification for a capital gain under the Income Tax Act.

“Fair market value” is not defined in the Income Tax Act. However, it has been established by various court decisions as being the highest price an artwork is expected to bring in the context of willing buyers and willing sellers in the appropriate “sales market” applicable to that artwork, and under no compunction to transact. Often times, in seeking to quantify the artwork’s value, the tax authorities will look at the original price paid by the donor as the starting point, as well as the qualifications of the independent appraisers who valued the artwork.

Acceptance

Many institutions will require that the donation of the artwork be approved not only by the relevant curator, but also by an acquisition committee or even by the institution’s board of trustees. This is not a quick process. Usually, acquisition committees sit only three or four times a year. If timing of acceptance of a donation of artwork is important for tax reasons (i.e. the receipt is required for a particular tax year), sufficient time has to be given to the institution to process the artwork for donation in accordance with the rules of the institution and the tax authorities.

The institution must be a ‘charitable organization’ in order to issue tax receipts. It will not wish to put its status in jeopardy for having a faulty donation acceptance program.

Certified cultural property

A donation may be made by a collector to an institution under normal donation rules for a tax receipt for fair market value of the artwork. However this process will result in a taxable capital gain to the donor based on the increased value of the work from the time of purchase to the time of donation. There may be different tax issues for an art donation made by an art dealer, or artists donating their own artworks, but that is outside the purview of this article. However, an art donation made under Canada’s Cultural Property Export Import Act may qualify for a special benefit given to the donor.

The European VAT: Good for Tax Revenue, Bad for the Commercial Art Market?

by Elizabeth R. Lash, Esq.

As an American, one might be forgiven for assuming that Europe, with its traditional support for the arts (at least, as a cultural phenomenon), would be equally supportive in its tax regime for the same. While in some limited instances, the European Union continues to provide a more favorable regime for the independent artist, the trend towards an ultimately higher value-added tax (“VAT”) on the sale, import and export of artwork, particularly with respect to art sold by galleries and in the resale market, may discourage the growth of an EU-wide commercial art market in comparison with more favorable tax regimes outside the EU.

VAT was initially intended to be used as a single tax rate applicable to all goods and services across all European Union member states. While the standard rate was originally set at 15% in 2006, member states could theoretically request reduced rates in one or two categories, set at no less than 5%. In reality, as each member state negotiated the terms of its entry into the EU, the list of categories has expanded to at least 21, with rates above and below the standard rates (which already varies from 17% to 27%), along with multiple categories of rates below 5% (zero rates, “parking rates” (i.e., rates negotiated with entry into the EU), and super reduced rates). As well, categories of rates are inconsistently drawn, from too narrow to overly broad: it includes, among others, such categories as printed books, e-books, cultural institutions, household cleaning, sporting facility use, bicycles, and writers and composers.

When it comes to artwork, VAT rates vary widely, ranging from 5% (Malta) to 25% (Sweden) (although there is a reduced rate for independent artists’ sales). In addition, VAT may be calculated on the margin (i.e., the difference between the original sale price and the purchase price), instead of under the standard or reduced rate (whichever is applicable to artwork in that particular member state). In a number of member states, the VAT may be set at multiple rates: one for independent artists; another for galleries and dealers; and still another for the import or export of art.

Further complicating this picture, the EU Commission may not only pressure (or even sue) a member state as to the categories for which reduced rates are permitted, but may also regulate individual tax cases affecting artists and collectors. One example in particular is the Flavin case, whose outcome confounded the international art community (and sets an unfavorable precedent in future, similar circumstances). In 2006, a British gallery (named the “Haunch of Venison”) imported two well-known American conceptual artists’ sculptures: Dan Flavin’s light sculpture, and Bill Viola’s video installations. The former consisted of several tubes of fluorescent lights, while the latter consisted of several audio-visual productions playing on various projection screens. The British customs office imposed a 20% rate instead of the reduced 5% rate for artwork. However, upon appeal to the British VAT and Duties Tribunal (the “Tribunal”), the reduced rate was re-instituted in 2008.

But despite this local regulator’s final decision (with no further appeal by the parties to the EU courts), the EU Commission weighed in anyway with its own regulation, issued in September 2010, which specifically overturned the Tribunal’s decision, ostensibly to effectuate the uniform taxation rules on imported goods. The EU Commission found that it was not the installations themselves which constituted artwork, but the results of such installations, whether of the “light effect” of Dan Flavin’s light sculpture, or the videos screened on Bill Viola’s video installations. Thus, in effect, the EU Commission found that the installations should have been taxed just as if a hardware or electronics store had imported lightbulbs and video components. For conceptual artists, this represented a major blow to the sale in and import of their artwork into Europe.

Then take Germany. Germany formerly assessed a reduced VAT of 7% on sales of art (other than photography). However, due to pressure from the EU Commission, which had opened proceedings against Germany regarding this reduced rate category, Germany passed legislation to raise the rate to 19%, effective January 1, 2014 (Germany’s standard VAT rate since 2007). In response, German federal legislators passed a national directive that permitted the tax to be assessed on only 30% of the purchase price, relying in part on an exception to the VAT directive that had been used in France for several years. But the application of this directive was restricted less than a year later by the German states to artwork priced under 500 Euros, and a few other categories, essentially undercutting the law’s essential purpose—to provide a more favorable rate for the commercial art market. Meanwhile, artists selling out of their studios remain subject to the 7% rate. While this may be acceptable for those select artists who sell out of their own studios, it does not bode well for those who are represented by galleries.

In 2014, in another instance of muddying the tax waters, the French government increased VAT on the sale of art in France from 7% to 10%, while still permitting imports of non-EU artwork to be taxed at 5.5%. Only a year later, the French legislators acknowledged this inconsistency, and reduced the VAT on direct sales by French artists to 5.5%, effective January 1, 2015. Meanwhile, in Spain, the current VAT on artwork was raised from 8% to 21% in September 2012, initially as part of the general rate assessed on goods and services related to “culture.” Within a year, after much hue and outcry, Spain decreased the rate again to 10%. Meanwhile, in Italy, the VAT on the sale and import of artwork is still 22%.

The dust may eventually settle on the various VAT rates and their application, but the newest wrinkle is a regulation (Council Implementing Regulation (EU) No 1042/2013) which changes how VAT is assessed—from the place of supply to the place of purchase. While this does not affect traditional visual artists and sculptors, it does impact those who are considered to supply services or goods digitally to consumers—for instance, freelance website designers. The regulation, effective January 1, 2015, requires such businesses to assess VAT based on the country of the purchaser, rather than the VAT of their own country, placing yet another burden on artists in figuring out the application of VAT—even though the regulation was meant, in part, to apply to the likes of e-retailers such as Amazon.com.

In light of the fluctuations in tax rates and their applications, with the ultimate trend inching towards a uniformly high VAT rate, the art market looks nowhere near as enticing in the EU as it does in those countries and locales not subject to the vagaries of the VAT rate debate. In the U.S., for instance, no VAT exists (although, of course, the U.S. does have a sales tax), and there is no import duty assessed on original works of art. Hong Kong does even better—it has no sales tax, import tax, or export tax on artwork. To some degree, the numbers back this up: according to an annual study conducted by Arts Economics for the European Fine Art Foundation, in 2013, the U.S. accounted for 38% of the global market by value, while the EU as a whole dropped 3% points to 32%. (The UK ranked separately at 20%–perhaps not a surprise in light of its 5% reduced VAT rate on artwork, the Flavin case notwithstanding.) Moreover, in the EU itself, the numbers for those member states with the highest VATs declined or remained the same. And while Hong Kong and Singapore did not rank individually as the top winners in 2013 (having perhaps to do with factors other than VAT or customs duties), still, such figures may show in part the effect of applicable tax regimes.

Then there are the so-called “free ports,” located around the globe, which have become popular as a way to store works of art intended primarily as an investment. A free port is essentially a tax haven: artwork may be shipped directly to the free port, and as long it is stored there, VAT will not be assessed on the import. (Of course, once the work is shipped outside the free port to its new destination, any applicable tax will be assessed.) An additional benefit for potential purchasers (depending on the local laws applicable to the free port) is that VAT may not be assessed on any sales of artwork made within the free port—at least not until the artwork has left the free port. (So, hypothetically speaking, if a sale has been made, but the work never leaves the free port, VAT will never be assessed.) Arguably, the art fair Art Basel became popular just for that reason, having made its initial home base in a Swiss free port. As of right now, there are free ports located in Switzerland, Luxembourg, Singapore, and Beijing. (One of the best indications of how popular the Singapore free port has become is that Christie’s auction house now has an office located there.)

The EU Commission has previously expressed that VAT rates are not to be used to control social and economic policy in the EU, and clearly is increasingly attempting to pressure member states, whether through regulation, litigation, or other alternative avenues, to raise VAT rates to a uniformly high rate. However, in the face of global competition, one can only wonder what this trend may mean for the EU in the future as a major player in the commercial art markets.

 

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About the Author: Elizabeth R. Lash, Esq., serves as in-house counsel at Kroll, where she focuses on reviewing agreements relating to cyber security and data breach notification.

DISCLAIMER: This article was prepared by Ms. Lash in her personal capacity; the opinions are the author’s own, and do not reflect the view of Kroll Associates, Inc. or of its affiliates.

Case Review: Crile v. Commission of Internal Revenue

By Chris Michaels, Esq.*

“All children are artists. The problem is how to remain an artist once he grows up.” – Pablo Picasso

For many artists, the financial instability that accompanies an artistic profession forces the artist to seek employment with a more consistent paycheck. A “day job” often provides the income for rent and bills while the artist continues to pursue their artistic endeavors. In this situation, tax deductions for expenses related to creating art may help the artist stay afloat financially. It seems like a fairly straightforward situation until April 15 rolls around and it is time to pay taxes. In a ruling filed by the United States Tax Court on October 2, 2014, the Court resolved a question of whether individuals who pursue their art while otherwise employed can deduct art-related expenses. The decision the Court reached helps artists to remain artists, even if they are not making a profit from their work.

Susan Crile Website

Susan Crile Website

The petitioner in this case, Susan Crile, has worked as an artist for over four decades. She has created more than 2,000 works using oil, acrylic, charcoal, pastels, and many other mediums. Her art is in the permanent collections of several museums including the Metropolitan Museum of Art, the Guggenheim Museum, the Brooklyn Museum of Art, the Phillips Collection, and several colleges and universities. In addition, her work has been purchased by corporations including Bank of America, General Mills, Charles Schwab, and several major New York City law firms. She has been represented by at least five New York City art galleries, most recently in 2009 by the Michael Steinberg Fine Art gallery. She has received awards from the National Endowment for the Arts and her works have been reviewed in almost every major art publication. Crile is also a full-time tenured professor of studio art at Hunter College in New York City, where she has worked in some capacity since 1983.

The respondent in this case, the Commissioner of Internal Revenue, determined that Crile had deficiencies in her Federal income tax returns for the years 2004, 2005 and 2007–2009. Specifically, respondent argued, among other things, that Crile was not entitled to claim deductions for expenses related to her artwork because she did not intend to profit from her art. The Court, therefore, was faced with determining the issue of whether Crile was engaged in a trade or business with the intent of making a profit from her activity as an artist. Crile’s artwork during the tax years in dispute included a series of works based on the life of Saint Francis in the Basilica di San Francesco in Assisi, Italy, works based on the events at the Abu Ghraib prison in Iraq, silkscreen printings, a series of small abstract paintings, and a project based on the prisoners in Guantanamo Bay.

Since her art career began in 1971, Ms. Crile sold over 300 works with gross proceeds of $1,197,150 and an earned income of $667,902. From 1971 to 2013, however, she never reported a net profit from her art business due, in large part, to the deductions she took for expenses relating to the sale of her art.

To determine whether Crile was entitled to the deductions she had taken, the Court considered two sections of the Internal Revenue Code, sections 162(a) and 183(b). Under section 162(a), deductions are allowed for “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” To be entitled to deductions under section 162(a), the taxpayer must show that he or she engaged in the activity with the intent of making a profit. Further, under section 183(b), if the activity is not engaged in for profit, deductions are not allowed except to the extent of gross income derived therefrom. Essentially, in order to take the deductions, Crile had to prove that she was in the art business to make a profit.

A threshold issue that had to be decided before the Court reached the issue of Crile’s intent to earn a profit concerned the scope of her activity as an artist. Under section 183(b), the activity to be considered can either be a “single undertaking” or “multiple undertakings.” The Commissioner argued that Crile’s art activity was not separate from her activity as an art professor and was thus a “single activity.” As a single activity, the Commissioner posited that Crile had to claim her art-related expenses as unreimbursed employee business expenses and not as deductible business expenses. The Court ultimately reasoned, however, that she had practiced as an artist for a decade before she had started teaching and that many activities she undertook as an artist were unrelated to her teaching career. As such, the Court held that Crile’s artist activities and professor activities were multiple undertakings that had to be analyzed separately under section 183(b).

The bulk of the Opinion handed down by the Court dealt with whether the artist conducted her art activity with an intent to earn a profit such that she could take deductions for expenses attributable to that activity. The Court analyzed the following nine factors and used a balancing test to determine whether Crile engaged in the activity for profit:

  1. The manner in which the taxpayer conducts the activity;
  2. The expertise of the taxpayer or her advisers;
  3. The time and effort spent by the taxpayer in carrying on the activity;
  4. The expectation of the taxpayer that assets used in the activity may appreciate in value;
  5. The success of the taxpayer in carrying on other similar or dissimilar activities;
  6. The taxpayer’s history of income or losses with respect to the activity;
  7. The amount of occasional profits, if any;
  8. The financial status of the taxpayer; and
  9. Elements of personal pleasure or recreation.

An analysis by the Court concluded that factors number one through five and nine were in favor of Crile and factors six and seven were in favor of the Commissioner. Factor number eight was neutral. As such, the Court held that Crile acted with the requisite intent to make a profit and, therefore, could take deductions for “ordinary and necessary expenses.” The Court reserved deciding on whether the deductions that Crile took were actually “ordinary and necessary.”

The Court’s decision in this case is a win for struggling artists everywhere. In finding that Crile engaged in her art activity as a distinct activity from her employment as a professor, the Court gave artists the opportunity to take deductions for expenses relating to their artwork as long as they are engaged in that activity for profit. While it certainly is not a windfall for anyone, the Court’s decision makes it a little easier for grown ups to remain artists.

Petitioner, Susan Crile, was represented by Robert H. Baron, Micaela McMurrough, and Megan Y. Lew, all of Cravath Swaine & Moore LLP. Respondent, Commissioner of Internal Revenue, was represented by Jane J. Kim and Michael J. De Matos of the Internal Revenue Service.

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About: Chris Michaels is a litigation attorney in the Philadelphia office of the Atlanta, GA-based law firm, Cruser & Mitchell, LLP, where he actively pursues his interest in the field of art law. He may be reached at (518) 421-7238, chriswmichaels@gmail.com, or on Twitter @CMichaelsartlaw.

Disclaimer: This article is intended as general information, not legal advice, and is no substitute for seeking representation.