Mel Leipzig knows about color. He also knows about line and form and composition. As one of the area’s more prolific and prominent visual artists, he knows a great deal about art and the art markets. But what Mel does not know, and will be the first to admit, is estate planning.
Leipzig is not alone.
Artists of all stripes focus on creating and stretching themselves into different modes of expression. However, they are silent when it comes to one of the most vital expressions of intent: what to do with their body of work upon death.
From the world famous to the local, most artists are in the same boat and do not know how best to handle their estates.
Mel Leipzig’s journey into the murky world of tax and estate planning is fresh in his mind. A widower, he experienced probate and the confusing world that opens when a loved one dies. Like all good parents, he wants to spare his children the heavy lifting that dealing with an unplanned estate entails. But once he determined to do something, it became evident there was not much information about what that “something” should be.
At first blush, Leipzig’s estate looks like any other. Having taught at Mercer County Community College for 45 years, he has a good pension. He has a house in Trenton and investments, nothing out of the ordinary — except an inventory of more than 350 original paintings in his house/studio, galleries, and many of them in secure storage.
Because his works hang in museums and private collections, there is clearly an established market for his art. The realist painter’s works range in value from $5,000 for a 24-inch by 24-inch canvas to $40,000 for larger, multiple-canvas works, such as the five-panel painting of Michael Graves. So when Leipzig decided to plan his estate, he followed the advice of his financial advisor and hired a respected appraiser to assess his unsold works. It was then that the first shock hit. The appraised value of Leipzig’s work sent his estate into taxable territory and him into a panic. “I couldn’t believe what I was being told,” he says.
Here’s why: Estates are subject to federal estate taxes when the value reaches $5,430,000 or more. On top of that, states also levy their own version of the estate or death tax. The appraiser, who had once done work for Sotheby’s Fine Arts Auction, came back with an amount that placed Leipzig’s net worth into taxable range. The artist’s estimated federal and state taxes would prove to be substantial and seemingly beyond the family’s immediate ability to pay.
And suddenly a whole new set of questions arose. If this was how an appraiser valued his inventory today, would the IRS value his unsold work more at his death? Would Leipzig’s executor have to sell most of the works to pay taxes? Would sales create a glut and depress the value of each piece? Who would control his artistic legacy? What should be done with all those paintings?
The now bewildered artist talked to friends and colleagues. With a great deal of hindsight but not much foresight, their advice was anecdotal and focused on what they too had experienced. He then sought advice from the most logical resources, estate planning attorneys. Even there, he could not, at first, get a great deal of concrete advice for his situation. Leipzig heard all sorts of wild ideas. “One lawyer even told me to remarry so that the estate and the art could be left to my spouse,” he says with a laugh. In theory that would postpone the payment of estate taxes until her subsequent death. Perseverance and the advice from the trustees of another artist’s foundation eventually led to expert advice from a New York lawyer and some legal sanity.
Leipzig’s experience serves as a cautionary tale. Not every estate planner is right for an artist. But, as the adage goes, knowledge is power.
Most of us have similar assets to consider when creating an estate plan: a house, stocks and bonds, and some bank accounts. We may also have a collection of jewelry, cars, or art. The market value of all these items can be readily ascertained through receipts or an appraiser.
We also have notions about how we want our estates meted out. Most of the time, heirs receive their inheritance with no strings attached. And we know who wants special items such as furniture, jewelry, or cars. If the estate hits the taxable level, it is fairly easy to reduce its value during life by giving money, real estate or other assets away to people or charities.
But life is not so easy for the artist whose estate contains a sizable number of unsold works and who wants to control his or her inventory while living, and after death.
Tax is a many-headed monster. There are income taxes, gift taxes, estate taxes, and other more arcane taxes. It is not just the federal government that levies those taxes. States have complicated rules about all of them and to make matters worse, each state is different.
So what’s an artist to do?
There are several approaches that can be used — singly or together — to help reduce the amount of art that is subject to estate taxes. Some can be implemented either during life or at death. But with estate law it is not as simple as it sounds.
First, how about an artist giving artworks as gifts to friends and family as a way of reducing the estate value? The answer is maybe. If you don’t own it, you can’t be taxed on it. So why not give the inventory away? While it is a great idea, there are tax consequences for the recipient. A work of art is worth only what it cost to produce it in the hands of the artist. Art given by the creator of the piece is considered ordinary income property to the recipient.
For example, if Leipzig gives one of his paintings to his friend Ben. It may cost Leipzig a total of $100 for paint and canvas to make the painting. Ben then sells it five years later for $1,000 and discovers there is income tax on the gain from the sale. The gain is the difference between the “basis” and the sale price. Since Ben’s basis in the work is $100, the gain is $900. Under income tax rules, that gain is treated as ordinary income, and taxes on ordinary income are much higher than the taxes on capital gains. So, ironically, it would have been better for Ben to buy the painting from Leipzig for $100. Then the painting becomes capital gain collectible property, and the $900 gain is taxed at the lower capital gains rate.
Gifting anything also carries with it gift and estate tax consequences. The good news in this bad news is there is a set amount that is excluded from gift taxes each year for every person to whom gifts are given. In 2015 that amount is $14,000. This means that an artist can give any number of family and friends, or anyone, gifts of art totaling $14,000 total each. For example, if Leipzig has five children, he has five chances to give aggregated gifts worth of $14,000 to each child, a grand total of $70,000. That amount then is no longer part of his estate. Gifting does reduce a bloated inventory rapidly as long as everyone is aware of the income tax issue.
Second, how about giving works of art to charity? Yes and no. This type of giving alleviates concerns about maintenance of the piece because museums will care for the work. It is a socially responsible way to reduce the inventory, and it can also raise the artist’s profile with critics, collectors, and the public. Again there is a slight problem because, just like giving a painting to a friend, the artist’s basis in the piece is only the cost of producing it, and that is the limit of the charitable deduction for income taxes.
Giving to a charity can also be a creative process and generate more creativity. An example is the arrangement created by well known Princeton artist Tom George. George, who died in 2014 at the age of 96, donated his works to the nonprofit Princeton Area Community Foundation to create the Tom George Artists Fund. By doing so, George transferred ownership of the works to the protection of the foundation, received a properly accessed tax-deduction, removed the works from his estate, saw that his work had a public presence, and gave the foundation the ability to sell works so funds are available for grants for artists (for more information, see pacf.org/connect/funds/thomas-george-artists-fund).
Third, what about putting the works in an irrevocable personal trust fund for a charity? Yes. As part of the overall estate plan, a Charitable Remainder Trust (CRT) is a valuable component. This handy vehicle achieves the hat trick of saving on income taxes, estate taxes, and meeting charitable goals.
Non-artists fund these types of trusts with liquid assets such as stocks, bonds, and cash because the trust must provide a payout to the beneficiary of the trust (the artist or family members) for life or a fixed term of years, and whatever remains in the trust at the beneficiary’s death goes to one or more designated charities. The payout can be a fixed percentage of the fair market value of the trust, determined each year, or it can be a flat percentage of the initial funding amount. The artist gets a charitable income tax deduction up front for creating the trust. In addition, the trust then owns the art and any other assets used to fund it, and those assets are effectively removed from the artist’s estate. Best of all, the artist’s charitable intentions are met because one or more charities can be named to receive the balance in the trust (the “remainder”).
When art is used to fund a CRT, things of course get complicated. The payout to the beneficiary is mandatory, so, in general, the trust must have liquid assets such as stocks, bonds, or cash on hand to make those payouts until the art is sold without resorting to a fire sale. Because the trust owns the art, there is a minimal income tax implication to the artist upon those sales. The trust is considered a charitable organization, so it is not taxed on the gains from the sale.
However, there is a way to fund a CRT with only art. The rules are extremely complicated, but the technique is very useful if the artist does not want to fund with liquid assets and there is no sense of how long it will take to sell the art once in the trust.
For example, Leipzig creates a CRT that has a distribution percentage of 6 percent annual for his daughter for life. He funds the trust with a painting that should fetch $500,000 on the open market. He then stipulates that the cash flow from the trust is not to begin until the painting is sold. If it takes three years to sell the painting, so be it. In this example, the painting actually sells for $600,000. When the proceeds of the sale ($500,000 after expenses) are in the trust, the trustee can begin making the payout to the daughter which equals $30,000 per year. The balance in the account gets invested. If the total return on the account is greater than 6 percent each year, the amount of the trust will increase. At the death of the daughter, the designated charities get the balance in the account.
An irrevocable non-charitable trust can also be established and funded before death. In order to remove the art from the estate, the artist must give up ownership of whatever part of the inventory he chooses to place in the trust. The irrevocable trust becomes the owner of the works. Naming a trustee who knows the art world and the market ensures that the pieces are well maintained and the subsequent sales accord with the artist’s vision of his or her legacy.
What about starting a foundation to keep the work together? Yes. One of the primary concerns for any artist is the preservation and control of a body of artwork. A very effective tool to achieve this is through the creation of a charitable foundation. While the foundation can be established under the terms of a will, doing it during life allows the artist to play a very active role in the foundation’s administration and to continue to contribute works. Because a foundation is a separate tax entity and owns the works contributed to it, those pieces are not part of the artist’s estate.
There are several different kinds of foundations. Private non-operating foundations must use donated art in a way related to its charitable purpose. Contributing art to a private foundation allows the works to be kept together and spares the family the problem of raising funds for estate taxes levied on the art if it is included in the estate.
An example of a private foundation is the George and Helen Segal Foundation created by the world famous South Brunswick based sculptor and his wife. According to the website, its mission is to “continue showing Segal’s work around the world, to give out grants to artists, to gift Segal’s work to museums and galleries, and to provide an authoritative place to purchase the art of this world-renowned painter, sculptor, and visionary.” For more information, go to www.segalfoundation.org.
Another type of foundation receiving a good amount of publicity lately is the private operating foundation. Artists are creating these in order to turn their homes into museums. Recent publicity has been negative because, as a January 10 New York Times article notes, some of these have been perceived as only marginally charitable entities that have “museum” access restrictions that are tantamount to no access at all. But for artists who genuinely want to create a space where their art can be enjoyed by others and who might have the room (not a personal residence), these are effective tools.
While these vehicles are valuable tools for artists to plan during life, there are two primary considerations that argue for waiting until death to dispose of assets. One consideration is very valuable to beneficiaries: the step-up in basis. If a person receives a work of art under the terms of a will (a bequest) or as part of the residuary estate, the person receives a “step-up” in the basis of the piece to the fair market value of the work at the date of death. This is a far cry from a basis that is limited to the cost of materials that comes with a lifetime gift.
As an example, revisit Leipzig and Ben. Leipzig has a painting he knows Ben loves, one that will be very valuable if sold. Rather than giving the painting to Ben as a birthday present, Leipzig makes a specific bequest of the painting to Ben in his will. When the artist dies, the painting is valued in his estate at $15,000 and that becomes Ben’s tax basis for the painting. Five years later, Ben sells the work at auction for $25,000. He is taxed at capital gains rates only on the difference between his basis ($15,000) and the sales price ($25,000) or $10,000. As shown earlier, if Ben had received the painting from Leipzig for his birthday, his basis would have been Leipzig’s cost in creating it (nearly zero). Ben would be staring at taxes on practically the full $25,000 and taxed at the much higher ordinary income rates to boot.
The second consideration is that an artist’s estate is allowed a deduction of 100 percent of the fair market value of a piece contributed at death to a charity.
The heart of the art problem is the hypothetical worth of an unsold piece of art. A working artist is constantly creating new pieces and building up an inventory of unsold pieces over time. But an unsold work of art has no absolute value, except that cost of materials. Yet the potential value of a work of art can be enormous. And guess what the IRS will want to look at when it is time to pay estate taxes?
The last thing a bereaved family needs is the anxiety that comes from having a large tax bill and no liquid assets to pay it. In Leipzig’s case, had he died shortly after his insurance appraisal was done and indeed his works were valued by the IRS for close to the appraised amount. “My family would have been looking at a tax bill of almost $1,000,000,” he says. How many artist’s families can find that kind of money without selling some or all of the art? Again the specter of a fire sale raises its head.
In order to avoid pitfalls such as large commissions on sales that will sharply decrease the amount the family actually receives from a sale, careful planning is required. In addition, family and advisors need to remember that if a work is sold during the period of time that the estate is being administered, that sale price may well fix the estate value upon which the tax is levied. What is a more concrete value than an actual sales price? Leipzig’s family can argue all they want that the piece was not worth much when Leipzig died, but if the piece sells for a high price shortly thereafter, the IRS says, “Bingo! That’s what the piece is worth.”
For some larger or complicated art-heavy estates, naming a specific art executor in the will is wise. If that person also acts as broker on sales, he or she receives compensation in the form of executor’s fees, which are always deductible.
For many reasons, it is vital to have an appraisal of the artist’s inventory by a reputable, qualified appraiser. Laurel Porcelli, director of appraisal services at Rago Arts & Auction Center in Lambertville, is such a person. She has worked with many central New Jersey artists and their families and seen both sides of the planning and the probate process. “The first appraisal is usually done to secure insurance coverage.” she says.
She points out that an insurance policy covering each piece on an itemized schedule requires a full appraisal before the policy is issued. “This type of coverage can be costly, and many artists opt for an umbrella policy that provides a specific amount of blanket coverage for loss,” she says. This is very helpful for people who have multiple residences or who are constantly creating more work. An appraisal is not always required before the umbrella policy is issued, although one would be needed in the event of a loss.
Appraisals are also important in documenting an artist’s body of work, and Porcelli advises, “Artists should catalog his or her inventory by photographing each piece; recording the title, medium, and dimension; noting the date it was created and its condition; recording the exhibition history.” Detailed records of sales are vital, providing additional data to help set values.
Appraisals for insurance or planning purposes settle value only as of the date that the appraisal is done. But estate tax calculations require the value be set as the date of death. So the art needs to be revalued, and the IRS requires an appraisal under oath to be submitted with the estate tax return when an estate includes articles having artistic or intrinsic value totaling more than $3,000. Although this is not a concern for estates below the federal taxable amount, states can have lower thresholds — with New Jersey low at $675,000. It is yet another thing to keep in mind.
This low threshold proves a problem for many artists. Porcelli says that for unsold works market comparisons are used to find sold works similar to those of the artist. Valuation becomes complicated if the artist’s work has only been sold once. The secondary market — sales after the initial transaction — provides a more precise and transparent way to determine a work’s fair market value.
Yet it is never simple. When seeking insurance coverage to protect from loss, the artist wants to secure a high valuation for the works. However, for estate tax purposes the opposite is desired; a low valuation means less tax. If numerous pieces will be included in the estate, the tax courts have sometimes allowed “blockage discounts” from the total retail value. The discount is allowed on the theory that a large number of works coming onto the market all at once will depress the value of all of the items. It can also help the estate to be concluded faster by settling the issue of valuation without waiting for the time it would take to sell the pieces individually to determine the fair market value of each.
This blockage discount does not apply for income tax purposes of charitable contributions. This is good news because for income taxes the highest possible valuation provides the highest deduction.
As nice as a discount sounds, there is a flip side. No artist wants to consider the effect of having a large number of works flooding the market and possibly diluting his or her reputation. The question of whether the market can absorb such an influx of works also arises.
In addition to a trust or foundation, many artists create an ethical will. This document, either written or videotaped, is the artist’s statement of intent for the disposition of the inventory, the desires for his or her lasting reputation, a declaration of what he or she has tried to convey during life. The ethical will has no legal effect, but it provides a strong moral obligation on the family and heirs to honor the artist’s vision. Often a writer is engaged to assist with drafting this potent expression of intent. It also is a vital means of documenting the works.
The Copyright Element. As with everything legal, there is always one more shoe to drop. In the case of art, that one more thing is copyright. Copyright comes into being when a work of art is created. Income tax regulations consider a work of art and the copyright to it as two interests in the same property. For this reason, if the artist wants to make a charitable contribution of a work and take a charitable income tax deduction for it, the copyright must be specifically transferred with the physical work. If the artist keeps the copyright, that creates a split interest, and the IRS disallows charitable deductions for gifts like that.
In addition, copyright ownership needs to be considered any time a work of art is given as a gift. Does the artist want the recipient to receive the rights along with the physical painting?
Estate tax rules consider the work of art and the copyright as two entirely separate property interests, in some instances. The artist can leave the physical work in his will to a public charity (or operating foundation) that will use the work in a way related to its exempt purpose, but the artist can also leave the copyright to another heir. Returning to Leipzig, splitting the interest allows him to give his son a continuing interest in the piece and provide a royalty to him each time a T-shirt or a postcard is produced. Whichever way the artist wants the two interests to pass, the will must be very carefully drafted so that the intent is unambiguous.
So where does all this lead? Because the tax landscape is so full of pitfalls and the mechanisms are so varied, artists must secure planning advice from highly qualified professionals. Ideally, a team of experts is needed. The attorney who drafts the estate plan needs to be experienced in handling artist’s estates. An appraiser knowledgeable in the artist’s specific medium is a key player. If the artist’s family is not capable of managing the inventory alone, a qualified advisor should be named as art executor in the will. The artist too has a singular responsibility to curate his or her own collection. See sidebar for pre-planning steps.
After much discussion and learning, Mel Leipzig may not know the ins and outs of estate planning, but he has a solid plan in place. He now has a trust and is considering a foundation to manage his inventory of unsold works.
And he also knows that one of the most important things he can do to maneuver through the estate planning morass is to communicate with family every step of the way. Losing a spouse or parent is painful enough without being plunged into taxation hell, and the last thing any artist wants to create is a plan so poor that the family is left in a worse position. Yet to do so, the artist needs to express his or her desires for the maintenance of the artistic legacy, and the heirs must express their desires or concerns too.
The planning process is an art and communication becomes the highest form of artistic expression. Just ask Mel Leipzig.
E.E. Whiting has worked for many years in trust and estates administration and in high net worth financial services. She is now a Princeton-based collaborative author and a contributor to U.S. 1.