The ultrawealthy most likely don’t have to worry about paying tax every year on their Cezannes or Rembrandts, but art industry tax advisers are still watching closely to see how their clients’ art collections would fare under the reconciliation bill.
“If this were to pass, I think it would be a whole new world with respect to planning for those individuals that come within its grip,” Michael P. Dunworth of Pryor Cashman LLP told Tax Notes.
The House-passed version of the Build Back Better Act (H.R. 5376) eschews the billionaire’s tax, a proposal that would annually tax the assets of the wealthy, but the proposal’s biggest champion hasn’t given up on it yet.
The House bill isn’t the final version of the legislation, Senate Finance Committee Chair Ron Wyden, D-Ore., stressed to reporters November 29. “Senators are not going to be potted plants,” he said.
The House’s effort to tax the wealthy — a millionaire’s surtax — doesn’t effectively tax the wealth, according to Wyden. “We now know that many billionaires pay little or no income taxes,” he said. Under the millionaire’s tax, such billionaires “wouldn’t be required to pay a dime.”
An added benefit of the billionaire’s tax is that the Joint Committee on Taxation has estimated that the proposal would raise a substantial amount of revenue, more so than the millionaire’s surtax, Wyden said. And it would do that while raising taxes on the fewest number of taxpayers, he added.
Dunworth agreed with Wyden on that point: “Certainly, it’s a very limited universe of people this would apply to,” he said.
Wyden introduced legislative text of his billionaire’s tax plan October 27, which fills in many of the blanks left from earlier descriptions of his proposal. Broadly, the billionaire’s tax would annually mark to market the publicly traded assets of applicable taxpayers — those with more than $1 billion in assets or with income exceeding $100 million for three consecutive years.
“If this were to pass, it would be a field day for the accountants and tax lawyers,” said Anne-Marie Rhodes, a Loyola University Chicago School of Law professor who teaches courses on estate and gift tax planning and art law. “And because this tax focus is the uber-wealthy, they are the ones who can underwrite that field day.”
What’s in a Word?
Unlike the millionaire’s surtax, which would be added to the existing income tax system, the billionaire’s tax would introduce a comparatively new tax regime that seeks to tap into the revenue potential of unrealized capital gains. The billionaire’s tax would annually tax gains and allow deductions for losses, including carrybacks and carryforwards, on publicly traded assets.
It would also collect a “deferral recapture amount” on all other non-tradable covered assets when they are deemed sold, which is intended to function as an interest charge on the tax that was deferred while the asset was still being held.
“One way I judge the complexity of a tax proposal is by how many new terms are employed and how many of them require multipart definitions. By that measure, it is very complex,” Rhodes said.
Among the new terms introduced by the billionaire’s tax, a key one is “tradable covered assets” — those assets that must be marked to market annually. That would tax assets with a readily ascertainable value, which at first glance suggests art would be excluded from the annual tax, observed Megan Noh, also of Pryor Cashman. Unique works of art require complex valuations, including reference to recent comparable sales and consideration of other market factors, she said.
But one question lingering in Noh’s mind is whether the recent rise of online platforms that facilitate transactions between buyers and sellers of artwork could be a string that ties at least some artwork to the tradable covered asset category. “Hopefully, Treasury will issue regulations to clear up this,” she said.
That outcome strikes other art industry observers as unlikely, at least for now. Pamela L. Grutman of Olsoff Cahill Cossu LLP countered that advocates of the proposal have made clear that the annual tax is intended to apply to marketable securities owned by the founders of large, successful start-ups who receive most of their compensation in the form of stock and who retain a substantial share of wealth in their holdings in their companies. A November 29 tweet by Wyden touting public support for the billionaire’s tax, for example, features an image of Amazon CEO Jeff Bezos, whose wealth is largely tied up in shares of his company.
Dunworth also said he thinks it’s unlikely that billionaires’ art collections are what legislators like Wyden had in mind for annual taxation when they crafted their tax proposal. Nevertheless, “as we have the proliferation of these online platforms, it just raises the question,” he said.
Rhodes said she shares the skepticism that art would be marked to market annually, explaining that the bill’s proponents probably don’t have the online platforms of traditional art venues such as Christie’s and Sotheby’s in mind, or even other, newer platforms that don’t yet rise to the “regular” standard of matching or facilitating the matching of buyers and sellers, as specified in the proposal.
“But who knows? Maybe [non-fungible tokens’] prominence is casting a shadow,” Rhodes said.
Stacking Taxes
If art is indeed a non-tradable asset, it could be in for some fresh tax treatment.
One of the most consequential changes would involve how gifts, bequests, and transfers in trusts are treated under section 494, Rhodes said. Under the proposal, any of those transfers would be deemed a sale for income tax purposes and would trigger the deferral recapture amount on top of the tax for any gain realized, she observed.
For lifetime gifts and transfers of art at death, wealthy taxpayers would have to contend with the gift or estate tax, and taxpayers who make gifts that skip a generation, such as to a grandchild, would also have to deal with a third layer of tax: the generation-skipping transfer tax, Rhodes said.
One exemption is transfers wholly to charity — for split-interest gifts to charity, the non-charitable portion would be deemed a sale and taxed. That could either put an end to split-interest charitable gifts, which museums may not like, or, conversely, billionaires might respond by giving the entirety of their art collection to the museum, Rhodes said.
Not All Bad
One possible outcome of the billionaire’s tax could be a shift from investment by the uber-wealthy in publicly traded assets to illiquid assets, including art — assuming it escapes the tradable covered asset category.
However, the art market is not monolithic; instead, individual artists have their own trends, Grutman said. “Blue chip” artwork — the most valuable segment of the art market — appreciates at more predictable rates and often outperforms the S&P 500, she said.
“Investing in emerging artists is a more speculative endeavor, but when an artist’s career is well managed, it is thought that their artwork will grow steadily over time,” Grutman said.
Another aspect of investing in art is that most art collectors treat their collections as long-term investments, Grutman continued. Although losses from depreciating artwork can be harvested, that’s typically not a useful tax planning strategy, she said, noting that tax advisers are far more likely to assist with income and estate tax planning as well as on charitable giving and other inter vivos transfers.
Known and Unknown Unknowns
Tax professionals have no shortage of questions when it comes to how the billionaire’s tax would apply in practice.
Dunworth wondered how, for example, prenuptial agreements would be dealt with. “Let’s say I have an art collection, [and] all of a sudden I marry some uber-wealthy woman, and now that has to be marked to market. That still needs to get worked through,” he said.
And even though art is likely to escape the tradable covered asset category and subsequent annual taxation, the many ways that transfers would trigger the tax that ordinarily don’t apply would complicate typical tax planning, Dunworth said. “It turns a lot of things on its ear,” he said.
Rhodes said that by all appearances, the billionaire’s tax was intricately drafted and with a clear ideological bent. “If it were to pass, it would upend the U.S. income tax world as we have known it. The consequences for all assets, including art, are hard to predict,” she said.
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