President Donald Trump addresses supporters as he speaks at the Indiana State Fairgrounds & Event Center September 27, 2017 in Indianapolis, Indiana. Trump spoke about the proposed Republican tax reform plan. Photo by Joshua Lott/Getty Images.
The White House’s framework for tax code reform, while thin on details, could have implications for art collectors and art-related businesses, experts said.
The nine-page proposal, released Wednesday, promises “more jobs, fairer taxes, and bigger paychecks.” It proposes eliminating many itemized deductions, and lowering the number of tax brackets to three from a current seven, to make filing taxes simpler. Lobbying groups have already jumped into the fray.
President Donald Trump has touted his tax plan’s benefits for the middle-class and has said it must be at least as progressive as the current tax code (meaning it will not shift the burden onto lower earners), but many tax experts noted the clearest beneficiaries are corporations and high earners.
In addition to lowering the highest individual income tax rate to 35% from a current 39.6%, it outlines several measures, such as repealing the estate tax and changing tax rates for small businesses, that could impact how art buyers and dealers operate.
For example, repealing the current 40% tax for estates valued at above $5.49 million “may significantly impact how collectors approach their estate planning,” said Micaela Saviano, who leads Deloitte Tax LLP’s art and finance practice. “Currently, collectors with taxable estates need to plan to address the significant estate tax on their art—an illiquid asset. Eliminating the estate tax would change that dynamic and perhaps motivate individuals to rethink where and to whom their art will go after their death.”
One thing the proposed reforms do not address, though, is how the tax code will treat inherited assets that have appreciated in value. Diana Wierbicki, who leads the global art practice of law firm Withers Worldwide, gave the example of a parent who would like to give a Willem de Kooning painting, purchased originally for $1 million but currently worth $3 million, to their child.
Under current tax law, the child would receive what’s called a “stepped-up basis” of the current value, in this case, $3 million, when they inherit it. That means that upon selling it, capital gains taxes are levied on the profit from a higher, or stepped-up, “basis.” So if the child were to sell it for $3.5 million in several years’ time, capital gains taxes would apply only to $500,000 profit, rather than a profit of $2.5 million from the parent’s original purchase price.
“If you get rid of the estate tax, what are you doing with the step-up in basis for income tax purposes?” Wierbicki asked. “You get a step up in basis for income tax, so when things are later sold, you pay less on the appreciation. Or is the child going inherit this $3 million piece, but they are then limited to the $1 million basis? That’s what we have to watch for to see.”
Nor does the proposal address whether tax rates for capital gains on art will be maintained. Taxpayers can choose whether to categorize, say, the profit from selling that de Kooning as either capital gains or ordinary income. Collectibles and art are subject to a capital gains tax of 28%, versus the highest income bracket tax of nearly 40%.
“The framework is silent with respect to the continuation of special capital gains tax rates,” said Saviano. “The possibility exists that the 28% rate now applicable to art sales may not be preserved into the future.”
That silence also raises questions for art dealers, who have to choose how to structure their businesses and how to categorize their art sales. The new proposal suggests lowering the maximum tax rate for small businesses to 25%, which means art dealers may be better off characterizing profits from art sales as ordinary business income rather than as capital gains from an investment, which may be subject to the slightly higher 28%.
“The question becomes, will they want to recharacterize how they hold art?” said Wierbicki.
The proposal retains existing deductions for residential mortgages and charitable contributions, explaining that “[t]hese tax benefits help accomplish important goals that strengthen civil society, as opposed to dependence on government: homeownership and charitable giving.” Wierbicki and Saviano noted the maintenance of the charitable giving deduction means museums and other arts institutions that rely heavily on philanthropic donations can breathe easy for now.
Many observers have noted that it is now up to congressional committees to figure out how to turn the proposal into actual legislation, and little can be known for sure until they present more concrete plans.
“While some of the headline changes might seem attractive to high-net-worth clients, the devil will be in the forthcoming details,” said Jonathan Traub, managing principal of tax policy for Deloitte Tax LLP.
May 4–8, 2018, Park Avenue Armory