Double Taxation: A Take On All Things Taxes

Earlier this week, I posted a link to an article detailing the desire of the IRS to hire a marketing firm to improve its image among the taxpaying public. Buried within the depths of the article was the reason for the Service’s PR push:

The IRS ranked last among 13 federal agencies in a 2010 survey by the Pew Research Center, which asked respondents if they had a favorable opinion of each agency.

This ranking should come as no surprise, as the IRS is the object of more scorn, derision and lazy Leno monologues than the entire Kardashian clan. But lest you start to think the public’s view of the IRS is unduly harsh, I encourage you to read this article authored by Janet Novack over at Forbes, which offers a stern reminder of just how illogical, oppressive and unyielding the Service can be.

As Novack explains:

After legendary modern art dealer Ileana Sonnabend died in 2007 at the age of 92, her heirs sold off some of her collection to pay a whopping estate tax bill: $331 million to Uncle Sam and $140 million to New York State….But they couldn’t sell Sonnabend’s most famous holding—Rauschenberg’s collage “Canyon”—because it includes a stuffed bald eagle, and two federal laws bar possessing or trafficking in the bird, dead or alive. [Ed note: Rauschenberg's "Canyon" is widely considered to be the world's second most sought-after piece of art, trailing only the Gummi Venus de Milo.]

Since “Canyon” couldn’t be sold without landing Sonnabend or her heirs in prison, the estate concluded that the work was worthless, and did not ascribe a value to it on the estate’s tax return. The IRS, however, had other ideas. After auditing the estate’s return, the Service set the value of  ”Canyon” at $65 million, and assessed the estate a tax deficiency of $29 million, tacking on a $11.7 million gross valuation misstatement penalty under I.R.C. § 6662 just for giggles.

When estate attorney Ralph E. Lerner — who is suing the IRS on behalf of the Sonnabend estate — reached out to the IRS for their rationale, this is what he got:

When he called the chairman of the IRS art panel to complain, Lerner reports, “He told me there could be a market. For example, a recluse billionaire in China might want to buy it and hide it.” [Ed note: I'm looking at you, Chou Kuang Piu]

If that’s the approach the IRS is going to take with taxpayers, I’d advise them to go ahead and double that PR budget. Come to think of it, they may want to allocate some additional funds to smoothing things over with the Chinese while they’re at it.

It’s exactly this type of ridiculousness that makes the IRS the most reviled of all the government agencies. The Service is taxing  the estate on the hypothetical purchase price a piece of art could fetch on the black market, even though such a sale would constitute a federal crime. This basically leaves the estate with two options: 1) hold on to “Canyon” and risk having to pay the tax, or 2) sell the work of art in order to pay the tax and go to rich-white-people-prison.

Scarier still, the IRS has put the Sonnabend estate in this predicament based solely on the contrived notion that somewhere in the Far East exists a wealthy eccentric with $65 million burning a hole in his pocket who’s been longing for a stuffed bird to tie his den together. Illogical, yes. Egregious? Definitely. But, sadly, not unprecedented:

So just how creative is the IRS being here? California art law attorney Joy Berus says she’s not surprised by the IRS’ position in this case. The government has long asserted (with some support from case law) that contraband items in an estate (drugs, stolen art, stolen jewels or a purchased artwork that turns out to be a protected antiquity, say belonging to foreign government or a Native American tribe) can be valued for estate tax purposes at their  black or “illicit market” value.

Joy Berus speaks the truth. See PLR 9152005 (stolen War World II art included in estate at black market value) and PLR 9207004 (weed included in drug dealer’s estate at retail street value). Needless to say, we’ll be keeping an eye on this case and will provide updates on any future developments.

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