Post Elkins v. Commissioner comes another interesting art case from Texas. The estate of media mogul Joe Allbritton and his widow, Barbara, are challenging the Internal Revenue Service on a $40.7 million tax assessment for the alleged distribution of $140 million worth of company-owned art to the Allbrittons.
Company-Owned Art
The complaint, filed in the U.S. District Court for the Southern District of Texas on Jan. 30, 2015.1 states that the art at issue was owned by Perpetual Corporation (the Company), a corporation owned by the Allbritton family or trusts for their benefit, which held art, real estate and other investment assets.
The Company had been investing in a variety of businesses and assets for over 50 years. As of 1999, the Company was the sole owner of 26 works of art. The Company also owned a 95 percent interest in six works of art. The Company acquired its 95 percent interest as repayment of debt owed by Joe to the Company (Joe retained a 5 percent ownership interest in such art). In 2001, Joe transferred 95 percent interest in 12 additional works of art again as repayment of debt and retained a 5 percent interest in such art. The Allbrittons’ reported gain from the 1999 and 2001 transfers on their tax return for those years. The Company later acquired two additional works of art from a third party with corporate funds.
The Company held the art in various corporate residential properties it owned, offsite storage facilities or, on a few occasions, the Allbrittons’ Houston residence. The Allbrittons paid fair market value (FMV) rent to the Company whenever they occupied the corporate residential properties. The insurance premiums for the art, which was all insured under one insurance policy, were paid for by the Company and Joe in accordance with their percentage ownerships in the art. The investment activities conducted by the Company with respect to the art included obtaining corporate financing with some of the art pledged as collateral and the sale of a Cezanne jointly owned between the Company and Joe that was sold at a significant gain.
Constructive Property Distribution
The Internal Revenue Service assessed tax on the Allbrittons on the basis that there was a “constructive property distribution” of art and insurance premium expenses by the Company to the Allbrittons in 2005, the first of the tax years at issue, or, alternatively, a constructive distribution of the “fair rental value of the artwork” for each of the tax years at issue. The taxpayer denied that there was a constructive distribution of the art, reasoning that the Allbrittons didn’t exercise or possess any ownership rights beyond that of any corporate officer or shareholder over corporate owned property, some of the art was jointly owned by Joe and the Allbrittons paid FMV rent for use of the residential properties that had held art (the rent including the value of furnishings). The taxpayer also asserted that if there was a constructive property distribution of the art, there shouldn’t also be a constructive distribution of the rental FMV of the artwork.
The IRS focused on the Allbrittons’ alleged free use of valuable art owned by a corporation that they controlled. As can be seen from this case, movable and “enjoyable” assets such as art present particular challenges for demonstrating treatment by taxpayers as separate corporate assets. Keeping company-owned art in corporate residences and storage facilities and requiring shareholders to pay FMV rent for the use of the corporate residences may not provide what the IRS needs to see to treat separate entity assets as separate.
The IRS’ answer is due on May 20, 2015, and it will be interesting to see how they respond to the issues raised by the taxpayers and how they develop the “constructive distribution” argument.
Endnote
1. Allbritton v. United States, S.D. Tex., No. 4:15-cv-00275, complaint filed, Jan. 30, 2015).