Sidney Janis transferred ownership of his New York City art gallery and its assets to a trust, with himself and his sons, Carroll and Conrad, as the co-trustees. Upon the elder Janis’ death, the sons inherited the estate, including the trust assets. The sons were also co-executors of their father’s estate, and they chose the alternate valuation date for the 464 pieces of artwork, which Sotheby’s appraised individually for a total of $25,876,630. The co-executors took a 52% blockage discount for the artwork on the estate tax return and valued it at $12,403,207. The IRS audited the estate tax return, and the IRS Art Auditing Panel reviewed most of the pieces of art. The panel arrived at a value of $36,636,630, but applied a 37% discount for blockage, arriving at a final value of $22,955,077.
The co-executors and the IRS agreed to a value of $14.5 million in 1994, and estate taxes were paid on that value. The sons then amended the trust income tax returns for 1990, 1991 and 1992 to reflect the Art Advisory Panel’s fair market value of $36,636,630, which increased the cost of goods sold and reduced the gain on their sale. The IRS audited the sons’ personal income tax returns for 1995, 1996 and 1997, when they were operating as a partnership, and issued deficiencies for each year. The sons and their wives petitioned the U.S. Tax Court, which agreed with the IRS.
Carroll and Conrad Janis appealed to the Second and Ninth circuits, respectively. They argued that policies motivating the application of the blockage discount to determine the fair market value of estate assets do not justify using the same market value when the asset is sold. Both circuits disagreed and affirmed the Tax Court’s decision.
The Second Circuit stated that using the same basis for estate tax purposes and later for income tax purposes avoids double taxation. The estate tax, based on the fair market value at date of death, taxes any unrealized capital gain. To avoid double taxation, the cost basis of inherited property that is later sold is the fair market value at the time of death, resulting in a step-up in basis. If the inherited property is later sold, the only gain that is taxed is on any increase in value after date of death. The court pointed out that the sons benefited from a lower fair market value as of date of death for estate tax purposes. They then attempted to reduce income taxes on the sale of the inherited property by using an undiscounted value as the cost basis for determining gains/losses.
The Ninth Circuit found the Tax Court correctly required Conrad Janis to use the artwork’s discounted value as the basis for calculating cost of goods sold from 1990 through 1997 because the duty of consistency promotes fairness and the administration of justice. The court found that the sons agreed with the IRS on a valuation of $14.5 million but took a different position after the limitation period.
Carroll Janis v. Commissioner , 98 AFTR2d
Conrad Janis v. Commissioner , 98 AFTR2d 2006-6075.
Prepared by Gary D. Rider , J.D., instructor of business, and Darlene Pulliam , CPA, Ph.D., McCray professor of business and professor of accounting, both of the College of Business, West Texas A&M University, Canyon, Texas.