The recent case of Estate of Kollsman v. Commissioner, T.C. Memo 2017-40 shows the perils to a taxpayer of a disregarded expert. Judge Gale found petitioner’s expert unreliable for several reasons, not including his basic qualifications as an expert, and relied, essentially exclusively, on the expert testimony offered by the IRS. Naturally, the estate did not benefit from this outcome. Why did the Court reject the testimony of petitioner’s expert and how can you make sure that your expert will not suffer the same fate? This post will focus on answering those questions.
I wrote a post recently on the IRS Art Advisory Panel. That post focuses on some of the work the IRS does to determine value. Today, the focus is on the taxpayer side although the same rules and concepts apply to respondent when hiring experts.read more...
The estate owned two paintings by “Old Masters” that became the subject of a valuation case in Tax Court. The estate hired a very qualified expert who was a “vice president of Sotheby’s North America and South America and cochairman of Sotheby’s Old Master Paintings Worldwide.” In addition, petitioner’s expert had known the decedent for many years and had periodically seen the paintings in decedent’s home for almost 25 years before her death. On the date Ms. Kollsman died, the expert wrote a letter to the executor providing preliminary estimates of the paintings if they were sold that winter by his auction house. The estate’s expert wrote two additional letters to the executor about four weeks after Ms. Kollsman died providing values for the paintings which the estate attached to its returns and providing an agreement for sale through his auction house.
The Court found the valuation letter and the agreement to use the auction house providing the appraisal too cozy. After walking through the basis for his opinion in the report, the Court states:
“We find Mr. Wachter’s valuations unreliable and unpersuasive for several reasons. First, he had a significant conflict of interest that could cause a reasonable person to questions his objectivity. Mr. Wachter first gave his fair market value estimates for the paintings at the time of decedent’s death (in amounts that remained unchanged in his expert report prepared for trial). His correspondence with Mr. Hyland [the executor] during that period demonstrates that the two had previously discussed the disposition of Maypole and Orpheus upon decedent’s death and that Mr. Hyland was considering selling the paintings. Mr. Wachter provided his fair market value estimates at the same time he was soliciting Mr. Hyland for the exclusive rights for five years to auction the paintings in the event they were sold…. Thus, Mr. Wachter, on behalf of his firm, had a direct financial incentive to curry favor with Mr. Hyland by providing fair market value estimates that benefited his interests as the estate’s residual beneficiary – that is to say, ‘lowball’ estimates that would lessen the Federal estate tax burden borne by the estate…. The fact that Mr. Wachter simultaneously presented Mr. Hyland with these fair market value estimates and his pitch for exclusive auction rights for Sotheby’s gives rise to an inference that the latter affected the former.”
Strong stuff, and Judge Gale did not stop there. He then pointed out problems with the valuation itself including an overstatement of the dirtiness of the paintings and the problems cleaning them might cause plus his failure to provide comparable sales supporting his valuations. Judge Gale points out that “we have repeatedly found sale prices for comparable works quite important to determining the value of art.”
With respect to the simultaneous valuation and business solicitation, the lesson from the Kollsman case is easy to draw. Do not use as your valuation expert someone who seeks to benefit from the relationship in ways that extend beyond compensation for services as an expert witness. The opponent in a valuation case always looks for ways to show that the expert is biased. Here, petitioners served up that basis on a silver platter. It is fine to use someone like Mr. Wachter to get an idea of the value of the paintings and fine to use him to assist in finding an expert. It might even be fine to use someone like Mr. Wachter to value the property on the return though I would not recommend it, but it was not fine not to use him as the expert at trial. For trial, the estate needed an expert whose testimony could not be impeached on the basis of a simultaneous business transaction.
Judge Gale’s concern that Mr. Wachter’s overstated the devaluation of the paintings based on their dirtiness is no doubt real but it serves, for me at least, to provide more support for the Court’s conclusion and not enough of a basis from which to draw general conclusions about experts. On the other hand, the judge’s observation about the absence of comparable sales in the expert report deserves attention.
Tax Court Rule 143 sets out the way expert testimony comes into evidence in Tax Court cases. The rule provides that the report of the expert serves as the expert’s direct testimony. For this reason, it is imperative that the expert write a comprehensive report that sets out the basis for the appraisal included comparable sales. While the attorney hiring the expert must be careful not to dictate the report, the attorney must also be careful to impress upon the expert the need for a full and complete report that documents the basis for the findings in the report. The Tax Court came to this approach after tiring of experts who played hide the ball with their reports and then came to Court and testified about many things on direct including the underlying basis for their conclusions.
I have not seen the report submitted by the estate in this case but the description by Judge Gale makes me believe that the report was short and conclusory. A person like Mr. Wachter with clear expertise concerning the subject matter but who may not serve often as an expert may have expected his clear expertise to carry the day in convincing the Court. While the depth of his expertise clearly matters, so does his report. Here, the description makes it sound as though the report lacked a major element and the Tax Court rules would prevent Mr. Wachter from fixing this mistake with his testimony.
After dismissing petitioner’s expert, the Court essentially embraces the report of the expert hired by the IRS. This result does not necessarily follow. There are times when the Court dismisses or heavily discounts the experts of both sides, but here the IRS expert proved persuasive. The Court discounts his opinions based on certain factors but uses the IRS expert report as the basis from which to build its determination.
It is worth noting that the IRS valuation report exceeded the amount determined as the value of the paintings in the notice of deficiency. This happens regularly because the IRS will rely on the Art Advisory Panel or other in house experts during the examination phase and not hire an expert until the case goes to court. The hired expert determined higher values that the IRS determined in the notice which would have caused the IRS to amend it answer to the petition in order to assert a higher deficiency and to take on the burden of proof with respect to the additional amounts. Of course, the additional burden does not mean much in a valuation case of this type. Here, the IRS made its motion on March 11, 2011, about two months before the trial.
Notice that it took the Court about five and one-half years after the trial in order to render the opinion in this case. While I do not think that is a record, it is certainly a long time to wait for an opinion. I have written before about the language in IRC 7459 which talks about the Tax Court deciding cases as quickly as practicable.
Practitioners headed into litigation need to vet the expert to make sure that nothing prevents the expert from rendering an impartial opinion. The petitioner is already paying for the opinion and an expert worth hiring will know what outcome the petitioner would like. No further incentive for the expert to reach a beneficial result for the petitioner should exist. Additionally, petitioners need to impress upon the expert what the report must contain and how the report will serve as the direct testimony of the expert in a Tax Court trial. Here, an individual with great qualifications as an expert in the field of art relating to the specific paintings at issue got disqualified for avoidable reasons.