A Rough Rider’s Eagle And The Estate Tax

What is the value of something that you cannot sell?

Someone walked face-first into this issue with the IRS.

We are talking about Ileana Sonnabend, an avid art collector and a very wealthy woman. She died in 2007, leaving an art collection that included works by Andy Warhol, Jasper Johns and Robert Rauschenberg. Her estate was in the billion-dollar range, prompting her executors to sell pieces from the collection to pay federal and New York estate taxes. Those taxes approached $500 million.

There was a troublesome piece in the collection – Rauschenberg’s “Canyon.” Rauschenberg was a post – World War II American artist, and some of his work is described as “combine.” This means that the work includes different materials, such as Picasso mixing sand into his paints. The issue with “Canyon” is that it includes a stuffed bald eagle.

There are federal laws – the 1918 Migratory Bird Treaty Act and the 1940 Bald and Golden Eagle Protection Act – that says that one cannot traffic in bald eagles, even a stuffed one.

Ms Sonnabend purchased “Canyon” in 1959, well after the 1940 law. In 1981 (yes, 22 years later) the Department of Fish and Wildlife contacted her to inform her that her ownership violated federal laws. She was able to obtain a permit to retain “Canyon” and loan it to museums, but she was forbidden to sell it. She got the permit because Rauschenberg – who made the piece – provided a written statement that the bald eagle had been killed and stuffed by one of Teddy Roosevelt’s Rough Riders, well before 1940.

The government decreed that it must be informed of “Canyon’s” location at all times. If the artwork left the country for an exhibition, it would have to apply for a visa.

Seriously?

Ms Sonnabend died. The executors had to put a value on “Canyon” for the estate tax return.

How do you value art for an estate? You get an appraisal. The estate got an appraisal on “Canyon” from Christie’s, the auction house. Their appraisal? It was worth zero – nada, zippo, subtract one from one. One cannot sell “Canyon” without going to jail, with greatly cuts into its marketability. Two other auction houses gave the same appraisal, so the estate filed an estate tax return showing a zero value for “Canyon.”

The IRS of course saw otherwise. In 2011 the IRS sent the estate a report proposing a value of $15 million for “Canyon.” The estate disagreed and refused to pay. The IRS – in an example of why people hate the IRS – issued a formal Notice of Deficiency upping the value to $65 million.

NOTE: It is not as though your local IRS revenue agent came up with this value. This is specialized work. The IRS has an Art Advisory Panel that helps with these cases. The most that a Rauschenberg has ever received at auction however is $14.6 million, which seriously calls their $65 million figure into question.

Just to put sand in the paint, the IRS levied a special “understatement” penalty of 40%.

So how did the bright bulbs on the Art Advisory Panel come up with the $65 million figure? One of them, Joseph Bothwell, said that there:

... could be a market for the work. For example, a reclusive billionaire in China might want to buy it and hide it.”

Huh? An illegal sale to a “reclusive billionaire in China” is not considered an accepted valuation technique.

Another bulb, Stephanie Barron, further explained that the Panel evaluated “Canyon” without reference to any restrictive laws.

“The ruling about the eagle is not something the Art Advisory Panel considered,”’ she explained.

What? The most important factor in “Canyon’s” valuation and you did not consider it?

We all just cringed at the idea that this had zero value. It just didn’t make any sense,” she continued.   

Good grief.

Let’s have a brief review of the facts for Stephanie Barron. Ms Sonnabend owned an item. The government did not approve of her owning the item. This item could be anything. Let’s say – for example - that it is a Big Gulp in Times Square. The government does not want you to have it and wants to take it from you. The government could call in a drone, I suppose, but it instead shows restraint. The government cleverly takes the item from Ms Sonnabend without actually taking it from her possession. Is that a fair summary of what happened here?

OBSERVATION: One could argue that Ms Sonnabend suffered a theft loss.

The executors had a decision to make. If they didn’t pay the taxes, they would face IRS collections action. If they sold “Canyon” to raise the money to pay the taxes, they would go to prison for violating federal law.

How did this turn out? This month the IRS dropped its claim against the estate of Ileana Sonnabend over “Canyon.” The estate donated the work to the New York Museum of Modern Art. The estate agreed not to claim a tax deduction for the donation, as it previously argued that the work had no value.

This was not the IRS’ finest effort.

Mormon Tithing and Caesar

George Thompson (GT) lives in New Jersey. He is the president of Compliance Innovations, Inc, which is owned by a trust. He and his wife are the trustees. He is a lifelong member of the Church of Jesus Christ of Latter-Day Saints (Church). He is a shift coordinator and a stake scouting coordinator with the Church. The Church does not pay him, however. He is married and has five children, two of whom are or were in college.

GT got himself into tax problems. He owed payroll trust fund penalties of over $150,000 for payroll periods in 2004, 2005 and 2007.

NOTE: We have spoken about these penalties before and referred to them as the “big boy” penalties. These penalties are for not submitting payroll tax withholdings and are some of the harshest penalties in the IRS arsenal.

He also owed regular “income tax” penalties for taxable years 1992, 1995, 1996, 1999, and 2000. These added up to over $730,000.

$150,000 plus $730,000 equals a lot of money. The IRS wanted it. I think you can see the problem.

The IRS begins its offense by sending a Final Notice of Intent to Levy, following up with an off-hand Notice of Federal Tax Lien Filing.  GT called time-out by filing a request for a Collection Due Process Hearing.

Let’s take a moment and explain what happened here. More than 25 years ago, Congress passed what has become known as the “Taxpayer Bill of Rights.” The intent was to introduce some formality to IRS Collections efforts, which too often operated as a Government Agency Gone Wild. GT applied the brake by requesting a CDP hearing. IRS Appeals would now step-in and look at how GT and Collections were behaving.

Before Appeals stepped-in, GT offered a “partial payment” installment agreement. You can guess that “partial payment” means that he is not paying off his tax in full. Collections requested a financial statement – a Form 433-A – providing GT’s income, expenses, assets and liabilities. The IRS wanted to see how much GT could pay.  

GT appeared to be doing well, listing monthly income of over $27 thousand with expenses of $24 thousand. He therefore offered to pay the IRS $3 thousand per month.

Seems fair, right?

The IRS looked at the same numbers and determined that he could pay over $8 thousand per month.

What? How could that be?

Trust me, it is easy – and common. The numbers are just magnified in this case.

When you get into this level of financial detail, the IRS classifies your expenses into two categories:

·        Necessary expenses

·        Conditional expenses

The IRS will generally disallow conditional expenses in a partial pay offer. GT had included approximately $5 thousand per month for Church tithing and college expenses. The IRS considered both to be conditional – and disallowed them. Bam! He could pay $5 thousand more per month.

Off go GT and the IRS to Tax Court.

GT leads off with Malachi 3:8-10:

Will a mere mortal rob God? Yet you rob me.

 But you ask, ‘How are we robbing you?’

In tithes and offering. You are under a curse – your whole nation – because you are robbing me. Bring the whole tithe into the storehouse, that there may be food in my house.”

The IRS fires back with Matthew 22:21:

Render unto Caesar the things that are Caesar’s, and to God the things that are God’s.”

The Court steps between the two with:

While we may be incapable of determining what belongs to God, we believe that we can, and must, decide what is Caesar’s.”

GT presented three different arguments to the Court:

(1) Given his position in the Church, tithing is required by the Internal Revenue Manual to be treated as a necessary expense.

(2) Classifying his tithing as a conditional expense is a violation of his rights under the Free Exercise Clause of the First Amendment.

(3) Classifying his tithing as a conditional expense is a violation of the Religious Freedom Restoration Act.

The Court dives into the first argument. It observes that the necessary expense test has two prongs: the expense must be for

·        The taxpayer’s health and welfare, or

·        The taxpayer’s production of income

For example, the Internal Revenue Manual allows a minister’s tithing as an allowable expense – if it is a condition of employment.

GT trots out a letter from his bishop that GT would have to resign his positions within the Church if he did not tithe. GT has a problem though, as the Church did not pay him. This would appear to present an obstacle. GT, undeterred, argues that the term “employment” in the Internal Revenue Manual is not limited to compensated employment and can include uncompensated employment.

Huh?

The Court observes that it cannot find any case specifically deciding whether the term “employment” as used in the Internal Revenue Manual is limited to compensated employment or can include uncompensated employment.

What? Can it be ...?

The Court reasons that there is a difference between a minister who is required to tithe in order to keep his/her job (and paycheck) and GT’s situation. It decides that the term “employment” must mean compensated employment.

GT argues that being active in the Church contributes to his health and welfare. The Court reflects on the interaction of religious observance and taxation, but does not agree that holding GT to his tax obligations compromises his health and welfare – or, at least, not any more than it compromises the rest of us.

GT next argues that not being able to tithe results in his being booted from Church office, thereby infringing his free exercise of religion.

The Court observes:

...petitioner overlooks the fact that it is his Church who is requiring him to resign his positions if he does not tithe. The settlement officer did not require petitioner to resign ...”

 And here is my favorite quote from the Court:

 “Petitioner’s claimed exemptions stems from the contention that an incrementally larger tax burden interferes with their religious activities. This argument knows no limitation.”

OBSERVATION: We know about Congress, taxes and “no limitation,” don’t we?

Let’s fast forward: GT loses his case. The Court is simply not going to let him treat his tithing and college expenses as a necessary expense when determining his partial payment installment offer.

My thoughts?  There are rules and guidelines when negotiating payment plans with the IRS. The more you want them to budge, the stricter the rules. The IRS did not budge an inch.  

I believe GT lost his case before he even went to Court. Why? Consider this quote from the Court:

Petitioner has a long history of not paying his taxes. As of the date of trial petitioner still had not paid his income tax liabilities for the taxable years 1992, 1995, 1996, 1999, and 2000.”

The Court was looking at GT as a deadbeat.

Here is the Court again:

Additionally, respondent has assessed trust fund recovery penalties under section 6672 against petitioner for seven different tax periods.”

Looking at? Nah. The Court had concluded that GT was a deadbeat.  

Killing Off The Tax Code

It will never happen.

Two months ago, Rep Bob Goodlatte (R, VA) sponsored H.R. 352, the “Tax Code Termination Act.” Since then approximately 70 additional Representatives have jumped onboard.

What does the bill propose to do?

Starting in 2018, the bill would eliminate individual, corporate, partnership and estate taxes. Payroll taxes and self-employment taxes would survive.

Congress would have until July 4, 2017 to propose and enact a new tax system to replace the current.

What is the purpose? Here is Representative Goodlatte’s explanation:

It has become abundantly clear that the tax code is no longer working in a fair manner for our nation’s citizens. Many Americans look at the dim state of our economy, and the billions of their tax dollars that are being given to private businesses and they want to know why they cannot keep more of their hard earned tax dollars. The tax code Americans are forced to comply with is unfair, discourages savings and investment, and is impossibly complex. It has become too clear that the current code is broken beyond repair and cannot be fixed, so we must start over.”  

He is not so much proposing the permanent abolition of the tax system as proposing a drop-dead date for its replacement. Why?

Although many questions remain about the best way to reform our tax system, I am certain that if Congress is forced to address the issue we can create a tax code that is simpler, fairer, and better for our economy that the one we are forced to comply with today.”

Congress won’t reach a consensus on such a contentious issue unless it is forced to do so.”

The bill is skeletal, and it does have an odd provision requiring a future Congress to meet a two-thirds majority to delay or repeal the bill.

Predictably, the very act of sponsorship has pushed the usual political suspects into a jeremiad, prophesying the end of the world as we know it.

Still, I can understand Rep Goodlatte’s premise: without prodding, the sinecured political class will not reform the tax system. Why would they? The tax code is just one more weapon they can and do wield to augment and retain power.