Managing the cookie jar: a parable about art and estate planning

Part I

Imagine a big ceramic cookie jar filled with options: chocolate-chip, snickerdoodle, macadamia-cranberry, even gluten-free macarons. You think it has something for everyone. Then your kids arrive. Blake and James fight over the one remaining gingersnap, while Sarah announces she dislikes cookies and only eats fruit. In the meantime, your family dog Iris waits impatiently, looking for leftovers she can gobble up.

Now imagine the jar, and its contents, are the valuables in your estate. You believed there would be something for everybody, but your kids are already squabbling over the assets, and one is feeling left out. Your dog Iris (remove the second vowel and you have the name of the government tax authority) is also interested in the contents of your estate.

We accumulate a lot of items in a lifetime. The tangible ones that usually determine our net worth (and “estate value” after we pass away) include real estate, investment portfolios and retirement accounts. Valuable collections, whether comprised of art, classic cars, jewelry or other high-value collectibles, are included in the value calculation as well.


The jar is empty, but the dog stays


Depending on the value of the entire estate, an estate tax, which is in essence a tax on your right to transfer property to beneficiaries at your death, may apply. The 2018 revised tax bill approved by Congress increased the federal estate tax exemption to $11.2 million per US domiciliary, meaning estates valued over this amount may be subject to an estate tax.1

In addition to federal taxes, there may be a state estate tax that applies as well.

There are some people who think that if they hide a lot of cookies, they won’t have to share as many leftovers with the family dog. One area where this can be seen is in the art market.

Since the art market is not regulated like the stock market, and there are no ownership deeds and rarely filed titles, some collectors may think that they can “hide” specific art assets.

In fact, not disclosing an asset does not help heirs or beneficiaries of the estate, and could have severe financial repercussions in the future. There is no statute of limitations on tax fraud—meaning charges could be made years afterwards. Lawyers at Ettinger Law Firm note in an article on estates with art assets, “Because art never truly ‘disappears,’ one does well to remember that neither does a tax liability.”2  Heirs can also be liable for penalties due if there is an underreporting of an estate or an asset’s value.

Fortunately for collectors, there are numerous options for managing estate tax scenarios that can benefit the estate owner, their beneficiaries, and even the family dog. The best way is to plan in advance.

Julianne Getty, Vice President at BMO Private Bank, observes why planning makes sense,

“The primary goals gained achieved through creating an estate plan are to one, minimize taxes and two, ensure that your assets transfer according to your wishes.”


Sorting your treats


One of the biggest challenges estate lawyers encounter is the lack of information clients have about their assets. “Surprises can be exciting and fun when you’re alive, but surprises after you die can lead to litigation nightmares,” observes Juliet P. Kalib, a Manhattan-based Trust and Estates attorney.

In the absence of a will or estate plan, heirs can end up in arguments—and costly legal battles. Imagine one example: if you have three children and one painting which is worth $1 million, your children may have different opinions on what to do. And if the values of your collectibles are not properly recorded, there is an additional expense of cataloguing and appraising the collectible assets. Executors for an estate are often subject to deadlines throughout the probate process (often just a few months), and the exact timing of these deadlines vary from state to state.

How can a collector avoid this scenario?

  • Keep a record of what you have, including receipts and invoices
  • Scan receipts of purchases and upload them into a digital file
  • Manage your collection on a simple excel spreadsheet, or utilize specific collection management software
  • Keep your documents in a secure place (check out our recent infographic for some storage best practices)
  • Consider drafting a will
  • Consider establishing a trust for your assets


The cookie jar’s Fair Market Value 


Once you have a list of assets, the next step is to understand the value your collection has within your larger estate value. This value may surprise you.

Let’s say you recently purchased a painting for one million dollars. This value is the amount you would insure the item for as well, since the recent purchase reflects the current Retail Replacement Value of the art. However, this same painting’s value will likely be different when considered within your estate.

The IRS uses Fair Market Value, not Retail Replacement Value, when considering the value of gifts, donations, and estate tax valuations. This is a very important factor, especially since Fair Market Value is usually less than Retail Replacement Value. For an overview of insurance valuation (Retail Replacement) versus Fair Market Value, see my recent post on art appraisals and insurance.

This is a crucial area for collectors to remember. Even if you have an insurance policy covering your art collection for $5 million, it does not correlate to having $5 million in art value that would be “taxed” within your estate.

A qualified appraiser can assess your collection for both insurance replacement and Fair Market Values. Essentially, they will produce two documents for you: one for insurance purposes, and one for estate and donation purposes. The Appraisers Association website makes it easy to locate a qualified appraiser in your area.


Insuring the cookie jar 


What happens if the cookie jar falls on the floor, resulting in crumbs all over the place? This creates an unfortunate possibility—the sweets can no longer be enjoyed by any of the kids!

Some collectors think that having an art insurance policy will alert tax authorities to the collectible assets a person has acquired over their lifetime. This may cause them to not insure their art properly. Unfortunately, this mindset is mistaken for a few reasons:

  1. Tax fraud, especially when it pertains to hiding to collectible assets, can have serious and long-lasting repercussions, per Ettinger Law Firm’s earlier observation
  2. The Fair Market Value is often less than the insurance replacement value
  3. The IRS would only be able to access insurance documentation with a subpoena

In life—as well as in estate situations—fortune tends to favor the prepared. Assembling an inventory and getting appropriate appraisals are the first steps toward creating an estate plan. A comprehensive art insurance policy for your collection protects the financial value of your collection for yourself and your beneficiaries during your lifetime. More details on philanthropy and legacy planning can be found in Part II of this series.

Katja Zigerlig is Vice President, Art, Wine + Collectibles Advisory at Berkley One (a Berkley Company).

1“An overview of the 2017 tax legislation: impact to individuals.” PricewaterhouseCoopers and Morgan Stanley Wealth Management. Dec 2017.