Monday, October 22, 2007

More on the Fractional Gifts Bill

I've now had a chance to look at the proposed Promotion of Artistic Giving Act, and it does appear that, if passed, it would live up to its name and bring the practice of fractional giving back from the dead. You can read the bill here.

I thought it might be useful to look back at my post from last September when the current law was passed ("The End of Fractional Gifts?") and see how things would be affected. Excerpts from the earlier post are in italics:

First, under the new law, … no deduction will be allowed unless all interests in the artwork were owned by the donor and the donee immediately before the contribution (unless everyone who holds an interest in the work makes a proportional contribution).

This would remain unchanged.

Second, if the collector fails to contribute her entire interest to the same museum before the earlier of (i) 10 years from the initial contribution or (ii) the collector's death, then all previous tax benefits are recaptured -- with interest, as well as a 10 percent penalty.

This would be changed. The deadline would now be 9 months after the collector's death (which is when the federal estate tax return is due).

Third, recapture also applies if during the 10-year period (or the period ending on the collector's death if sooner) the museum fails to take "substantial physical possession" of the artwork - reversing the Winokur rule that the "legal right" to possession is sufficient - and "used the property in a use which is related to" its charitable purpose. …

This would remain unchanged, except that, since the 10-year period would no longer apply, presumably the museum would have to take possesson at some point prior to the nine-months-after-date-of-death deadline. (For more on the "substantial physical possession" requirement, see here and here.)

Fourth, and worst of all, the new law provides that the fair market value of any additional contributions shall be determined by using the lesser of (a) the fair market value of the work at the time of the initial contribution or (b) the fair market value of the work at the time of the additional contribution. This creates two problems for collectors. One, they're deprived of the benefit of any increase in the value of the artwork over time. Say I donate 25% of an artwork to a museum at a time when the work is worth $8 million and, several years later, when the work is now worth, say, $20 million, donate the remaining 75%. Under the new law, my deduction for the latter contribution will be limited to $6 million (75% of the value at the time of the initial contribution), even though what I have donated is an asset worth $15 million (75% of $20 million, the value at the time of the later contribution).

This "lesser of" rule would be completely eliminated. In its place, the new bill provides only that, in the case of annual additional contributions in excess of $1,000,000, the fair market value will be determined by the IRS Art Panel.

Even worse - and this is the part that will likely mean the end of fractional giving to museums unless changed - the law sets up a potential mismatch between the work's taxable value and its deductible value. To see this, suppose that tomorrow a collector gives a museum a one-half interest in a painting valued at $5 million. Her current deduction will thus be $2.5 million (putting aside the usual percentage limitations on charitable deductions). Suppose further that she dies several years from now, leaving the remaining one-half interest to the museum in her Will - but imagine that now the value of the painting has gone up to $6 million. Now the estate tax charitable deduction will be limited to $2.5 million (one-half of the value of the painting at the time of the initial contribution), but the full $3 million (one-half the painting's current value) will be includible in the collector's estate, leaving estate tax due on the $500,000 "spread." Ouch.

This too would be eliminated - and it's this that would mean the end of the end of fractional giving. By dropping the "lesser of" rule, this "mismatch" problem disappears as well. The estate tax charitable deduction would go back to being identical to the amount includible in the collector's estate.

The same problem applies to gifts as well. Using the same example, if rather than leaving the remaining one-half interest to the museum in her Will, the collector decides to complete the gift during her lifetime, she will have to pay gift tax on - but will get no income tax deduction for - the same $500,000 spread.

Again, this problem would be solved by the elimination of the "lesser of" rule.

The new law applies to contributions made after August 17, 2006.

The changes made by the new bill would apply as of the same date.

So, all in all, the proposed bill would succeed in undoing most of the damage done by the Pension Protection Act. Now let's see if it passes.