Catch-22 Inheritance Tax

The absolute certainty of death and taxes poses an unavoidable estate-planning question for owners of artworks: how will they be valued for inheritance tax purposes?

A recent valuation dispute between the US Government’s Inland Revenue Service and heirs of the late New York art dealer and collector Ileana Sonnabend has become an artlaw cause célèbre.

It concerns Robert Rauschenberg’s iconic combine, Canyon, 1959.
 Canyon memorably includes a ‘taxidermied’ black bald eagle attached to the bottom of the canvas, wings outspread as if flying towards the viewer; above it are crudely painted shapes, underneath it a rope hangs down and below the canvas tied around the middle of a small pillow. The work references Rembrandt’s The Rape of Ganymede, 1635, depicting the Greek myth of Jupiter as an eagle kidnapping the baby Ganymede whose arm is clutched in its beak and whose body hangs with naked rear and legs exposed to view.

 The provenance of the stuffed eagle used in Canyon is central to subsequent events. Rauschenberg was given it in 1959 by a fellow artist Sari Dienes who had found it in the trash can of a recently deceased neighbour. The neighbour had been a member of Teddy Roosevelt’s Rough Riders and had ‘acquired from the wild, a bald eagle which he had taxidermied prior to 1940’. 1940 is a crucial date because in that year US Congress enacted the Bald and Golden Eagle Protection Act which, together with the Migratory Bird Treaty Act 1918, created criminal offences for any person to ‘take, possess, sell, purchase, barter, offer to sell, purchase or barter, transport, export or import, at any time or any manner, any bald eagle … alive or dead, or any part, nest, or egg thereof’.

 Canyon was shown in 1959 at Leo Castelli’s New York gallery and was acquired by his then wife Ileana Sonnabend. She loaned it for significant shows throughout the US and Europe, including the 1964 Venice Biennale where Rauschenberg won the foreign artist grand prix. Canyon first came to the notice of US law enforcement officials in 1981 when, on its return to the US from a European touring show, the US Fish and Wildlife Service became aware of ‘the peculiar situation involving a protected bird carcass that was affixed to a great American masterwork’. The Service contacted Sonnabend, who was eventually granted a special permit allowing her to keep possession of the bald eagle (and therefore the work) on strict conditions: the Service should always be notified of Canyon’s whereabouts; it could never be sold within or outside the US; and export licences would be required for future foreign exhibition loans.

 However, in 1998 the Fish and Wildlife Service refused Sonnabend an export licence to allow Canyon to travel to Bilbao’s Guggenheim Gallery for a major Rauschenberg retrospective exhibition. It had taken the Service 17 years to realise that it had made a mistake in granting Sonnabend export licences from 1981 onwards: such licences could only be granted to non-profit institutions. As a result, the Service required Sonnabend and/or her gallery to prove that they enjoyed non-profit status (which they could not); or that Canyon’s bald eagle was ‘taxidermied’ before Congress enacted the Bald and Golden Eagle Protection Act in 1940. An affidavit recounting Rauschenberg’s acquisition of the stuffed bird was submitted to the Service – and was accepted. Accordingly, Sonnabend made indefinite loans of Canyon to two non-profit institutions: the Baltimore Museum of Art until 2003, then the Metropolitan Museum of Art in New York, where it currently resides.
 At her death in 2007, Sonnabend remained owner of Canyon and it was inherited by her children Nina Sundell and Antonio Homem. Sonnabend’s entire art collection was valued at around $1bn, and the two heirs sold works of substantial value to raise the funds to pay federal and state inheritance taxes of around $600m. However, they did not sell Canyon: it was appraised by three independent experts, including Christie’s, who opined it had no market value because it could not legally be sold; any such sale would violate US federal law (the Bald and Golden Eagle Protection Act 1940 and the Migratory Bird Treaty Act 1918). Nevertheless, the appraisal of the US Inland Revenue Service (IRS) valued Canyon at $65m. IRS required Sonnabend’s heirs to pay $29.2m inheritance tax on the work (at a special penalty rate because IRS judged the heirs to have filed an erroneous inheritance tax valuation).   They are also required to pay a further $11.7m in interest/penalties for non-payment: in total, $40.9m.

 The heirs are caught in a Catch-22/Kafka-esque trap; according to their art lawyer Ralph Lerner: ‘The IRS is saying you have to pay the tax. If you sell the work to raise the money to pay the tax, it’s a criminal offence and you go to jail.’ And so the heirs’ recent lawsuit challenges and seeks to set aside these IRS decisions not only because Sonnabend ‘complied with strict government regulations for more than three decades’ according to Lerner, but also on the basis of the IRS’s allegedly bizarre valuation and penalty decisions.

 US law regarding inheritance tax valuations is very similar to the UK and most other developed countries. Valuations are required to be conducted according to ‘fair market value’ prevailing on death of the asset’s owner – including ‘any restrictions, understandings, or covenants limiting the use or disposition of the property’. Such valuations are made initially by an Art Advisory Panel of independent art market experts. The Panel offers recommendations to the IRS, which is not required to accept them. It appears that the Panel’s recommendation for Canyon did not take into account that the work could not be sold legally, nor that the highest publicly recorded sale of a Rauschenberg work to date is the $14.6m achieved by Overdrive, 1962, at Sotheby’s in 2008.

 Lawsuits are expensive, and can be protracted and stressful. Were there no alternative actions the heirs could have taken to avoid or mitigate their inheritance tax liabilities? It appears not: even if the heirs were to donate Canyon to a non-profit institution – such as the Metropolitan Museum of Art where its current indefinite loan could be converted into a gift – the heirs would nevertheless be required to pay the tax penalties and interest of $11.7m. Moreover, it is possible that such a gift would in itself violate the 1940 Act that makes it a criminal offence to ‘take, possess … transport, at any time or any manner, any bald eagle … dead’.
 Hopefully, the court deciding this lawsuit will use plain common sense in judging whether it is ‘fair’ to ascribe any ‘market value’ to Canyon for tax purposes. And the heirs’ art lawyers might usefully cite in aid of their suit the Wall Street Journal’s constructive comments on the current ludicrous impasse (‘Bald Eagle Is a White Elephant Thanks to Uncle Sam’, 26 July 2012, D10, US edition): ‘The IRS valuation isn’t necessarily crazy, even if its justification … is. But thanks to federal law, that value is entirely hypothetical. How arbitrary is it to take a good off the market and then demand taxes be paid on an imaginary, indeed illegal, market price?’

© Henry Lydiate 2012

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This article is from the Artlaw Archive of Henry Lydiate's columns published in Art Monthly since 1976, and may contain out of date material. The article is for information only, and not for the purpose of providing legal advice. Readers should consult a solicitor for legal advice on specific matters. Artists can get free online legal information from Artquest.