Preserving the artist's heritage


January, 2017

Robert H. Louis

Saul Ewing LLP

(215) 972-7155

fax (215) 972-1826

  Many people postpone planning their estates, not wishing to confront issues of mortality; or, it may be that they believe the subject so complex that no amount of effort will yield any useful results. They may shrug their shoulders and say "I'll let my kids worry about it", not realizing the significant burden they are imposing on the next generation and the likelihood that far greater tax liabilities will be incurred by doing nothing.

Estate planning, for artists and others, should not be considered a process impossible to understand and not worth the time spent. Much can be achieved with a few hours of work. The result will be that the burden on the next generation will be greatly lessened and the taxes imposed at death may be substantially reduced.

Writing a Will

What is a will? It is simply a statement of what you want done with whatever you own at the time of your death. It can be as simple as a letter of instructions. The important points are that it must clearly be a direction of what is to be done, and it must be signed and dated. In some states, there may be more required in the way of formalities, but generally this is what is needed to insure that your assets, including your art, go where you want them to go. It's probably a better idea to have a formal will drawn up, and for this you should consult a lawyer. While there are sample form wills available on computer programs and in the local pharmacy, this is too important a project to have it done without expert advice. A will drawn up by a lawyer will add some more formal language, but it will cover issues that you might not have thought of on your own, such as who will be your executor, the person who carries out the terms of your will, and who will be the guardian of minor children.

Will Substitutes

Not everything you own will necessarily pass by will. Certain assets may contain their own provisions determining where they go upon your death. A good example of this is life insurance. The proceeds of life insurance will go the persons you name as your beneficiaries, on a document that is kept on file with the insurance company. Similarly, the beneficiary of any pension or profit-sharing plan benefits, or individual retirement account benefits, will be the persons you name on a beneficiary designation form filed with the plan administrator or financial institution holding the IRA.

Many people own property in joint names. Typically, a home owned by two people will be owned jointly, and this also occurs quite often with bank accounts and brokerage accounts. For most joint accounts, except those called "tenancies in common", the survivor will be entitled to the entire value of the asset when one of the owners dies.

These will substitutes must be reviewed to determine where the assets covered by them will go. They must also be considered along with the will to obtain a picture of the entire estate plan, where all of your assets will end up.

Death and Taxes

Most people pay federal and state income taxes during their lives, generally every year, and the Form 1040 and the tax rates are well known. Less well known is the fact that both the federal government and, in many cases, the state government will impose taxes at death on the value of all that the decedent owned, including the value of artworks. That is, even if you have paid income taxes on what you have accumulated during life, it will be subject to tax again at death.

Federal estate taxes have changed significantly in recent years.  In 2017, the federal estate tax will be imposed at a rate of 40% on taxable amounts in excess of $1,000,000, with graduated rates up to that amount. There is an exemption of $5,450,000 before the tax is imposed, increased to $10,900,000 for married couples.  Assets up to that amount may be passed free of federal estate tax. This may seem like a sufficiently high number to avoid tax in almost every case, but the tax is imposed on the value of IRAs and other retirement accounts, the value of your home, and the proceeds of life insurance policies, in addition to stocks and bonds, bank accounts, and artworks. The threshold may be exceeded when the these assets are totaled.

Federal estate taxes have another very important offset: you may leave any amount to your spouse with no imposition of federal estate taxes on the transfer. Thus, it is possible to avoid all or nearly all tax on the death of the first spouse, simply by leaving everything to the survivor. This may not be the disposition you want of all of your assets, but it is a valuable deduction that can assist in planning to minimize taxes.

The combination of the estate tax exemption and the marital deduction can produce very significant reductions, or the elimination, of federal estate tax. By using trusts set up under a will, it is possible to provide for the survivor and pass on to the next generation the maximum amount possible under the federal tax system.

What will 2017 bring in new estate tax legislation? It’s impossible to say at this point. The tax might be repealed, or replaced with a capital gains tax at death. Change could occur quickly or be phased in over a period of years.

Many states still impose death taxes of their own. Pennsylvania imposes an inheritance tax on the assets owned at death, to the extent they do not pass to the surviving spouse. New Jersey exempts transfers to the surviving spouse and descendants. Florida imposes no inheritance tax, as do a few other states.  It's important to review what your state death tax liability would be in your state of residence. By the way, what is your state of residence? Some people live most of the time in one state, but try to claim they are actually residents of another state, like Florida, to avoid inheritance taxes. This is a technique that must be carried out with careful planning, to avoid claims by two (or more) states that taxes are owed to it.

Planning Techniques to Lower Tax Liability

There are a number of techniques that may be employed to reduce the burden of death taxes. First, you can give assets away during your lifetime to family members. In doing so, you should be aware of the possible imposition of federal gift tax. The gift tax is similar to the estate tax, with the same rates and threshold exemption. In addition, you may give up to $14,000 per year (in 2017) to any number of persons without incurring gift tax or using up any of the lifetime exemption. If your spouse joins in the gift, the $14,000 exemption is doubled. Gifts beyond these amounts use up part of your lifetime exemption and, if large enough, can result in the payment of gift tax currently.

How do you give something away? You must intend to make a gift, and you must deliver the gift. You probably should not, for example, give away artworks but keep them in your home for the rest of your life. That might not be considered a completed gift. In making gifts, as well as in determining the value of your estate for estate tax purposes, the issue of the valuation of artworks will be important, and the subject of valuation is discussed in another section of this publication.

In addition to giving artworks and other assets to members of your family and to friends, you may also reduce your taxable estate by giving assets to charities. This may include, for example, giving artworks to a museum. If the museum accepts the work, its value will be out of your estate, just as any assets left in your will to charities will escape death taxes. In addition, you may take a deduction for income tax purposes for the value of assets given to charity. This creates a double benefit of reducing your income tax liability and your estate tax liability. This rule is, however, subject to a very important exception: you may not take more than a modest income tax deduction for the value of art you have created. Your deduction is limited to the usually nominal cost of the materials purchased in creating the art. By contrast, you may take an income tax deduction for the full value of art created by someone else and donated by you. This occasionally gives rise to schemes to get around the limit on the income tax deduction by making various types of transfers. Sometimes this works, and sometimes it doesn't, depending on how it is done.

In conclusion: Plan ahead

There is no substitute for thinking about the disposition of your assets, including artworks, both during your life and afterward. The process of estate planning takes some time, but the reward is usually substantially reduced tax liability, and almost always a clearer idea of what one has and what will happen to it. The certainty and peace of mind this process can lead to justifies taking time and expending the effort to be prepared for the inevitable. You and your family and friends will benefit in many ways.